Are New Businesses At a Disadvantage in the U.S.?

Source: Thinkstock

Source: Thinkstock

“It appears to have become increasingly advantageous to be an incumbent, particularly a mature one, and increasingly disadvantageous to be a new entrant in the American economy.” This is the ultra-simplified conclusion of a study published by The Brookings Institution, which took an in-depth look at the shifting landscape of American business, and in particular, the dramatic fall of business dynamism.

Business dynamism is used to describe the trends in the marketplace in which firms enter and go out of business. It is a metric that can be called up on to easily summarize the state of entrepreneurship in a given economy, and help visualize the overall state of the business world. Previously, we’ve discussed how business dynamism is linked with the concept of ‘creative destruction,’ the natural process by which companies compete with one another. If business dynamism is the theory of evolution, then creative destruction is natural selection, to compare the concept to an established scientific alternative.

As you may have guessed from The Brookings Institution’s findings, business dynamism in the United States is not showing promise. In fact, it hasn’t for some time. The rate at which businesses are entering the American business biosphere has taken a dramatic turn for the worse, while the number of companies leaving the economy has seen a rather meteoric rise. Not at all inspiring for entrepreneurs, which may actually perpetuate into a sort of self-fulfilling prophecy.

As with anything, there is definitely more than one way to look at things. The nuances of the American economy know no depth, as the economy itself is famously intensely intricate in both design and function. So what can we make of the rapid decline in business dynamism? In the end, what will we be faced with if the trend continues? Another question we arrive at is whether or not declining business dynamism is a good thing or bad thing. So how do we make sense of it?

Source: Brookings

Source: Brookings

The chart above from Brookings represents the visual portrayal of the decline in American business dynamism. Obviously, the rate of firms entering the economy has seen a substantial drop. On the other hand, the number of companies exiting the economy has really remained relatively the same since the late 1970s and early 1980s, although it has spiked a bit over the past few years. Of course, the chart only details the numbers until 2011, and given the state of the economy, it’s reasonable to assume that both the exit and entry rate have continued on their respective courses.

Again, the findings from the study indicate that the longer a company has been in business, the more likely it is to survive. Despite the influx of small businesses and startups over the past decade, the big boys still rule the schoolyard, and success for the little guy is hard to come by.

There are many factors that actually play into this, including the inclination of newer companies — like giant tech and software companies, for example — to gobble up would-be competitors before they can gain traction in the marketplace. Other industries simply have an incredibly high barrier to entry. An example would be the automotive industry, which requires an immense amount of talent, capital, and resources to get started in. There have been some examples of success in that field, particularly Tesla and the up-and-coming Local Motors, but it is still out of reach for most entrepreneurs.

From their findings, Brookings issues some valid concerns and dangerous warnings if the rate of dynamism continues to sink lower. “The trends described here raise some cause for concern in our view. Holding all factors constant, we’d expect an economy with greater concentration in older firms and less in younger firms to exhibit lower productivity, potentially less innovation, and possibly fewer new jobs created than would otherwise be the case,” the report reads.

This is the ultimate danger of seeing business dynamism decline. But again, there are also other ways of looking at it.

Source: Thinkstock

Source: Thinkstock

Another article, this time from The American Enterprise Institute, details exactly how the force of creative destruction has changed the business landscape over the past five or six decades. In crunching the numbers, it was found that only 12.2 percent of the companies listed in the S&P 500 in 1955 are still around today, meaning that the tides of time and evolving market has a relatively potent method to cycle firms in and out of the economy.

The article’s conclusion? “The constant turnover in the Fortune 500 is a positive sign of the dynamism and innovation that characterizes a vibrant consumer-oriented market economy, and that dynamic turnover is speeding up in today’s hyper competitive global economy.”

In other words, we need creative destruction to work its magic to restore business dynamism to a more sustainable level. Otherwise, the warnings issued by Brookings might come to fruition. The government plays an integral part in setting things back onto the right track. We know that people respond to incentives, so how can we get people to live out their entrepreneurial dreams by innovating and starting small businesses or startups?

The obvious answer is for the government to help lower the barriers to entry for entrepreneurs who want to take a chance. There are regulations on many industries, as well as high taxes, that dissuade many from jumping in the fray. Of course, there are regulatory measures in place that are pivitol to protect both consumers and the environment, but as we all know, the government does have a tend to overreach. Revisiting some of the current policies on the books and retooling them to inspire more entrepreneurship would be a start.

Another issue to be addressed is inflation, which can also be linked to things like wage stagnation. Government spending is also out of control to a large degree, which has an effect on some of these factors. In order to secure a more prosperous future, all signs indicate that we need to find a way to increase the levels of business dynamism, or we could be facing a stagnating and deteriorating economy. How to do that exactly is an incredibly complicated endeavor, but it needs to be addressed.

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