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1 53056_Kauffman_vers1:1 2/25/10 9:52 AM Page 1 Kauffman Foundation Research Series: Firm Formation and Economic Growth Where Will The Jobs Come From? November 2009 Dane Stangler and Robert E. Litan Ewing Marion Kauffman Foundation February 25, 2010 10:28:38 53056_Kauffman_vers1.pdf 1

2 53056_Kauffman_vers1:1 2/25/10 9:52 AM Page 2 Dane Stangler is a senior analyst at the Kauffman Foundation. Robert E. Litan is vice president for Research and Policy at the Kauffman Foundation. The authors are grateful to Ron Jarmin and Javier Miranda at the U.S. Census Bureau, Mike Horrell at the Kauffman Foundation for excellent research assistance, and Harold Bradley, Wendy Guillies, Paul Kedrosky, E.J. Reedy, and Carl Schramm for their feedback. ©2009 by the Ewing Marion Kauffman Foundation. All rights reserved. February 25, 2010 10:28:39 53056_Kauffman_vers1.pdf 2

3 53056_Kauffman_vers1:1 2/25/10 9:52 AM Page 1 Kauffman Foundation Research Series: Firm Formation and Economic Growth Where Will The Jobs Come From? November 2009 Dane Stangler and Robert E. Litan Ewing Marion Kauffman Foundation Kauffman Foundation Research Series: Firm Formation and Economic Growth | Where Will The Jobs Come From 1 February 25, 2010 10:28:39 53056_Kauffman_vers1.pdf 3

4 53056_Kauffman_vers1:1 2/25/10 9:52 AM Page 2 Introduction Abstract Compared to all prior recessions since the end of World War II, the 2007-2009 recession ranks worst in terms of the number of jobs lost (over eight million), and second worst in the percentage decline (6 percent). The key to economic recovery will come in the form of newly created jobs. But where will these jobs come from? Using United States Census Bureau data from 2006-2007, this paper examines net new job creation in size terms of firm age rather than firm . Until 2005, we knew that from 1980-2005, nearly all net job creation in the United States occurred in firms less than five years old. This data set also shows that without startups, net job creation for the American economy would be negative in all but a handful of years. If one excludes startups, an analysis of the 2007 Census data shows that young firms (defined as one to five years old) still account for roughly two-thirds of job creation, averaging nearly four new jobs per firm per year. Of the overall 12 million new jobs added in 2007, young firms were responsible for the creation of nearly 8 million of those jobs. Given this information, it is clear that new and young companies and the entrepreneurs that create them are the engines of job creation and eventual economic recovery. The distinction of firm age, not necessarily size, as the driver of job creation has many implications, particularly for policymakers who are focusing on small business as the answer to a dire employment situation. decline—and given that the last two employment Introduction recoveries were much longer than the postwar 3 At no time since 1945 have so many jobs average, they could be right. disappeared so rapidly in the United States. Naturally, then, everyone is asking: where will the Compared to all prior recessions since the end of new jobs come from? The answer—though it has World War II, the 2007-09 recession ranks worst in mostly been missing from policy discussions, is that terms of the number of jobs lost (over eight million), we will get new jobs from where we always have: and second-worst in the percentage decline (6 new firms. 1 Still worse, the broadest unemployment percent). measure, U6, has touched ridiculously high levels— Prior work from the Ewing Marion Kauffman nearly one in five workers—and the number of Foundation has shown that, since 1980, nearly all 2 Put hours worked per week has steadily decreased. net job creation in the United States has occurred in 4 these together with a rapidly falling employment-to- This is an impressive firms less than five years old. population ratio, and the U.S. employment situation figure, but it doesn’t convey the whole story of job has not looked so bleak in several decades. creation in America—the turmoil and churn of new Compounding this dreary picture, more than a few firm creation, young firm survival or failure, and the forecasters see a long and slow recovery from this scale growth of some firms. New data from the U.S. 1. See Floyd Norris, The Jobs News Gets Worse , NEW YORK TIMES, Oct. 3, 2009, at http://www.nytimes.com/2009/10/04/weekinreview/04norris.html. 2. The U6 indicator captures the total number of unemployed workers (which is what is usually reported as the standard unemploy ment figure), plus “all marginally attached workers, plus total employed part time for economic reasons.” That is, U6 includes people who have stopped looking for work and those who have had to 2, at find part-time work instead. See Bureau of Labor Statistics, “The Employment Situation—September 2009,” Oct. 2, 2009, Table A-1 http://www.bls.gov/news.release/pdf/empsit.pdf. 3. Norris, supra note 2. 4. See John Haltiwanger, Ron Jarmin, and Javier Miranda, “Jobs Created from Business Startups in the United States,” Kauffman F oundation, January 2009, at http://www.kauffman.org/uploadedFiles/BDS_Jobs_Created_011209b.pdf. Kauffman Foundation Research Series: Firm Formation and Economic Growth | Where Will The Jobs Come From 2 February 25, 2010 10:28:39 53056_Kauffman_vers1.pdf 4

5 53056_Kauffman_vers1:1 2/25/10 9:52 AM Page 3 Employment in the United States Census Bureau now allow us to peer under the (89 percent), they also account for only a small economic hood, as it were, and tell a more fraction (less than 20 percent) of total employment. comprehensive story about job creation. And it is In fact, those companies that account for only a this story—that new firms have been and are likely sliver of the population of companies employ the to continue to be the real engines of job growth in “other” half of American workers. Firms with more America—that should occupy the attention of than 500 employees represent only 0.3 percent of policymakers and perhaps provide some cause for employer firms, yet account for just under half of optimism amidst the continuing gloom about jobs. employment within firms, and over half of firm payroll. This makes sense, of course—larger companies, even when there are fewer of them, Employment in the will account for an outsized share of employment simply by virtue of their size. But the discrepancies United States here are quite noticeable, and belie the conventional A commonly heard statement in any employment narrative about “small businesses” and jobs. This discussion is that “small businesses” account for half becomes even more apparent when we look at of the labor force and are therefore the key to the most detailed classifications of firm size future generation of jobs. This is roughly true: firms and employment. with fewer than 500 employees (the somewhat Across these standard categories, the largest share questionable cutoff between “small” and “large” of employment is in firms with more than 10,000 companies used by the Small Business employees, followed by companies with 20-499 Administration) employed 50.2 percent of workers 5 employees; likewise with payroll. In general, then, Sensibly enough, in “employer firms” in 2006. the U.S. economy is comprised of a very large employer firms are those companies that have number of small companies, accounting for a small employees, as distinguished from “nonemployer” share of employment; a relatively small number of firms, which are companies comprised of only the medium-sized companies, accounting for about a founder. If we take the entire workforce, firms with third of employment; and a tiny handful of very fewer than 500 employees accounted for about large firms, accounting for a relatively sizeable 42 percent in 2006. Not everyone would define a portion (about a quarter) of employment. We have a small business this way, so we can drill down a bit none-too-surprising inverse relationship among firm more to two smaller firm size classes: those 6 size, number of firms, and overall employment. employing fewer than 20 employees, and those employing 20-99 employees. The point of this is not to belittle the employment contributions of small businesses or to laud those of As shown in Table 1, whereas the smallest large companies, but instead to underscore that companies (fewer than twenty employees) analyzing employment in terms of firm size actually account for an enormous share of all companies Table 1: Distribution of Employment, by Selected Firm Size Classifications Share of Employer Share of Employment Share of Share Size Class of Firm Firms Labor Force of Firm Payroll in Firms 89.29 18.02 <20 employees 15.15 14.96 20-99 employees 8.89 17.58 14.59 15.48 <500 employees 99.69 50.22 41.69 44.42 >500 employees 49.78 41.33 55.58 0.30 Table 1. Source: U.S. Census Bureau, Statistics of U.S. Business, at http://www.census.gov/econ/susb/. available at 5. Small Business Administration, “The Small Business Economy 2009,” U.S. Government Printing Office, 2009, http://www.sba.gov/advo/research/sb_econ2009.pdf. 6. This has been documented in prior work. See, e.g., Robert L. Axtell, Zipf Distribution of U.S. Firm Sizes , 293, SCIENCE 1818 (2001). Kauffman Foundation Research Series: Firm Formation and Economic Growth | Where Will The Jobs Come From 3 February 25, 2010 10:28:39 53056_Kauffman_vers1.pdf 5

6 53056_Kauffman_vers1:1 2/25/10 9:52 AM Page 4 Where the Job Creators Are d st t ion of Em p loymen t Figure 1: Di ribu Payroll Acro ss Firm S ize s an s t y y p e iz S Firm ss roll Acro Fi g ure 1: Di st ribu g ion of Em p lo y men t an d Pa y d n a d Kauffman Foun ion t a t Kauffman Foun io 0–4 5–9 10–19 20–99 100–499 10,000+ 500–749 750–999 2,499–4,999 1,000–1,499 5,000–9,900 1,500–2,499 ize of Firm by Number of Em p loyee s S Figure 1. Source: U.S. Census Bureau, Statistics of U.S. Business, at http://www.census.gov/econ/susb/. tells us very little about job creation. It would be the behavior of existing firms and the subsequent more accurate, and much more revealing, to discuss impact in terms of net job creation. 7 employment in terms of firm age. The dynamics of firm age, moreover, point us Where the Job away from a discussion on the existing distribution of employment and toward a focus on the annual Creators Are changes in jobs. Let’s ask not where people work, As we have noted, nearly all net job creation since but where each additional increment in net job 1980 has occurred in firms less than five years old. If creation occurs. This approach immediately forces we want to know more about the dynamics of one to recognize that companies in a given size class young companies and how they affect existing are not necessarily homogenous: a company with companies—and perhaps the sectoral distribution of fifteen employees that is twenty-five years old will new companies—we need to look at the data a little behave differently than one that is only two years more closely. Fortunately, a recent Special Tabulation old (differences that will multiply if we classify firms done by the Census Bureau for the Kauffman according to economic sector). To answer the Foundation has provided a wealth of information on pressing question of where new jobs will come these very issues, and we will now present some of from, therefore, we need to understand the ceaseless dynamic of new firm entry and exit, and these findings. 7. Other research funded by the Kauffman Foundation and conducted by Census Bureau researchers clearly establishes this general principle, but has not yet been published. Historically, the United States statistical infrastructure, like those in most of the world, has not been equipped t o track changes in business composition. Dynamics of businesses, particularly new and young companies, were not of much concern. This has recently been changing, in the United States and elsewhere. Kauffman Foundation Research Series: Firm Formation and Economic Growth | Where Will The Jobs Come From 4 February 25, 2010 10:28:40 53056_Kauffman_vers1.pdf 6

7 53056_Kauffman_vers1:1 2/25/10 9:52 AM Page 5 Where the Job Creators Are In general, the net addition of jobs from year to source of immediate job creation for the U.S. year (i.e. job creation) comes from three sources: economy. startups; young firms, ages one to five; and the Figure 2 has a remarkable implication: “excluding largest and oldest companies. There is evidently the jobs from new firms, the U.S. net employment somewhat of a barbell effect, with job creation 9 Indeed, growth rate is negative on average.” occurring at the youngest and oldest ends of the without startups, net job creation for the American 8 This firm age spectrum, and mostly flat in between. economy would be negative in all but a handful isn’t the whole story, however, as there is a of years. considerable amount of churn—job creation and destruction—occurring in the youngest companies, But not every startup sticks around—roughly a as well as an interactive dynamic between the third will close by their second year of existence, youngest and oldest firms. 10 This means the while half will make it to age five. jobs that many firms create at birth will Let’s begin with startups (defined in the data as subsequently disappear, so part of their positive “age zero” firms). Over the past thirty years, these contribution to jobs in one year will turn to newly created companies have served as a primary ource of Job Crea u t ar St ion: t ps S st Figure 2. The Fir 0 t m u ion F a d Kauffman Foun o d a t ion Kauffman Foun d 1982 1991 2004 1979 1981 1993 2005 2001 1983 1987 2002 1992 1980 1989 2003 1985 1984 1978 1999 1996 1986 1990 1977 1994 1988 2000 1997 1995 1998 Figure 2. Source: U.S. Census Bureau, Business Dynamics Statistics, at http://www.ces.census.gov/index.php/bds. 8. We should again emphasize that we are discussing job creation: the inflow and outflow of employment in firms of every age isn’t reflected in the net figure. So net firms in the middle part of the spectrum, those aged six to twenty-five, still hire people in gross. But every class of compani es also lets go of a substantial number of people, and employees leave voluntarily. There is constant churn in terms of people flowing in and out of firms, but some class es of firms have a higher inflow than outflow and greater pool of firms, thus generating a positive net figure. 9. Haltiwanger, et al, supra note 5. Kauffman Foundation Research Series: Firm Formation and Economic Growth | Where Will The Jobs Come From 5 February 25, 2010 10:28:41 53056_Kauffman_vers1.pdf 7

8 53056_Kauffman_vers1:1 2/25/10 9:52 AM Page 6 Where the Job Creators Are st for Large t Accoun s Figure 3: Young Firm S hare of Job Crea t ion d Kauffman Foun a t ion t Percen s g. 11–15 t k. Lef j. 26–28 h. 16–20 i. 21–25 d ore e. 1–5 Cen f. 6–10 Firm Age Figure 3. Shares of annualized net job creation in 2007. See text. Source: Special Tabulation by U.S. Census Bureau for Kauffman Foundation from Business Dynamics Statistics. positive contribution from the “left censored” subtraction in the next few years. No economy could long survive if every year’s new jobs were simply category: the oldest companies. As discussed below, eliminated within such a short period. So what this highlights the continuing dynamic between about the other half of startups, the fifty percent young and mature companies wherein the latter rely that survive until age five? This represents our on the former not only for jobs but also innovations second major source of net job creation. and thus revenues. Using the special tabulation from the Census These charts raise an obvious question: isn’t age Bureau, we can see that, among existing companies merely serving as a proxy for size? That is, when we in 2007 (excluding startups), young firms accounted talk about “young” firms aren’t we really talking for the lion’s share of job creation—roughly two- about “small business”? To address this, we can 11 thirds, in fact. translate Figures 3 and 4 into size classifications. When we look across all firms of all ages, we do see What this means is that in 2007, while the largest somewhat of a skewed distribution by size of share of employment remained in the oldest and company: the firms responsible for net job creation largest companies (the “left censored” category in are not only young but also small- and medium- Figure 3), young companies, those aged one to five, sized (Figure 5). had been the most dynamic in adding new jobs to the economy. Of the entire pool of new jobs added What happens when we look only at young firms, in 2007 (roughly 12 million), about two-thirds was those aged one to five? We see a similar breakdown generated by these young companies. This critically by job growth and firm size (Figure 6). important fact about job creation becomes even It would appear, then, that firm age is somewhat clearer when we translate Figure 3 into absolute coterminous with firm size. This makes sense numbers and look at lifetime net job creation for because most young firms will tend to be small: very firms of different ages. few grow to enormous size in their first three years Again, firms between the ages of one and five of existence. create the most net new jobs, dwarfing the other But there is a further way to approach job growth age classes. These firms also create the highest in the United States: the sectoral breakdown of job average number of jobs: roughly four jobs per year. We also see in Figures 3 and 4 an apparently growth, which should shed some light on the Files/the-economic-future-just- 10. See Dane Stangler, “The Economic Future Just Happened,” Kauffman Foundation, June 2009, at http://www.kauffman.org/uploaded happened.pdf. 11. Calculated by Census as two-thirds of annualized lifetime net job creation computed as total lifetime creation by firm age. Kauffman Foundation Research Series: Firm Formation and Economic Growth | Where Will The Jobs Come From 6 February 25, 2010 10:28:42 53056_Kauffman_vers1.pdf 8

9 53056_Kauffman_vers1:1 2/25/10 9:52 AM Page 7 Where the Job Creators Are d s t for t he Mo st Job s Figure 4: Young Firm Accoun an Highe st Average Number of Job s Crea t e d ion t a d Kauffman Foun ds an s Thou d t Cen s ore h. 16–20 g. 11–15 e. 1–5 i. 21–25 j. 26–28 k. Lef f. 6–10 Firm Age Figure 4. For change in employment 2006-07. Source: Special Tabulation by U.S. Census Bureau for Kauffman Foundation. hare of Ne t Job Crea t ion by Firm S ize: 2007 Figure 5: S Kauffman Foun ion t a d t Percen 0 o 4 o 9 t o 99 t o 19 o 49 t o 499 o 249 o 999 t t t t t o 4,999 o 2,499 o 9,999 t t t c. 5 b. 1 . 10 f. 50 e. 20 d m. 10,000+ i. 500 g. 100 h. 250 j. 1,000 l. 5,000 k. 2,500 S ize Firm Figure 5. Source: Special Tabulation. Generally S mall- t o Me d ium- S ize d Com p anie s Figure 6: Young Firm s t Kauffman Foun a d ion t Percen 0 o 4 o 9 o 99 t t o 19 o 49 t t t o 499 o 999 o 249 t t t o 4,999 o 9,999 o 2,499 t t t b. 1 c. 5 . 10 f. 50 m. 10,000+ d e. 20 i. 500 h. 250 g. 100 l. 5,000 j. 1,000 k. 2,500 ize S Firm Figure 6. Share of Lifetime Net Job Creation by Firm Size, Young Firms only, 2007. Source: Special Tabulation. Kauffman Foundation Research Series: Firm Formation and Economic Growth | Where Will The Jobs Come From 7 February 25, 2010 10:28:43 53056_Kauffman_vers1.pdf 9

10 53056_Kauffman_vers1:1 2/25/10 9:52 AM Page 8 Symbiosis, Churn, and the Wave Effect t In d u st rie s ? s Job st Figure 7: Wha t ing t Have Been Crea he Mo Kauffman Foun d a t ion Job t Ne d ion, 2007 t Crea hare of Annualize S s e s s s e g t s d a ie st ail ale ion ion erv t t t s t Mfg erv st S ili S t Wh Re urance Wa h Care ruc of Co Mining s t ci/Tech uc U t d sp st S d her E t Real E Whole Informa O Heal Con Mgm Tran Accom Foo Prof/ min an d A Finance In Figure 7. Source: Special Tabulation. dynamic among young, mature, small, and old firm employment in a sector and its job growth (Figure 8). companies. By contrast, there is an incredibly tight relationship Taking the most general breakdowns by business 12 between any particular sector’s job growth and the it shouldn’t be too surprising that there is a sector, performance of young firms within that sector rather wide spread among industries. It is well (Figure 9). established that at any given point in economic time, some sectors will be outperforming others. The bottom line: young companies are the We need only look at the importance of information engines of job creation. technology over the past decade as well as studies showing that the American productivity resurgence since 1995 has been heavily concentrated in just a Symbiosis, Churn, and the 13 handful of sectors. Wave Effect In particular, we have recently seen strong job Clearly, the important fact that young companies creation in retail, health care, accommodation and are primarily responsible for net new job creation food services, and professional, scientific, and has many implications, particularly for policymakers technical services, while sectors such as educational as they confront a dire employment situation. We services and information appear to have lagged. This will highlight three: the symbiosis between young distribution isn’t altogether surprising: retail, health and mature companies; the churn of employment care, and accommodation and food services happen and companies; and the effect of new companies to be among the largest sectors in terms of through time. employment and number of companies (Figure 7). Above, we mentioned a barbell effect with regard What is more interesting about the sectoral to job creation: startups and young companies breakdown is what it reveals about the dynamic account for a large share of new jobs. But one thing between firm size and age. In particular, there is that stands out from the preceding charts— very little relationship between the amount of small particularly Figures 3, 4, and 5—is that the largest 12. NAICS two-digit sectors. 13. See, e.g. , Diana Farrell, Martin Baily, and Jaana Remes, “US Productivity After the Dot Com Bust,” McKinsey Global Institute, December 2 005, at http://www.mckinsey.com/mgi/reports/pdfs/usproductivity/US_Prod_After_Dot_Com.pdf. Kauffman Foundation Research Series: Firm Formation and Economic Growth | Where Will The Jobs Come From 8 February 25, 2010 10:28:43 53056_Kauffman_vers1.pdf 10

11 53056_Kauffman_vers1:1 2/25/10 9:53 AM Page 9 Symbiosis, Churn, and the Wave Effect t d ion s hi p Be t ween Firm S Figure 8: No Much Rela In d u st ry Job Grow t h t t ize an s loymen p loyee p ry Em st u d <500 Em s of In t ion t a d Kauffman Foun in Firm 14 16 12 18 02 4 6 810 Percen ion In d u st ry S hare of Annualize d Job Crea t Figure 8. Authors’ calculations from Special Tabulation and Census Bureau, Statistics of U.S. Business. Figure 9: In d u st ry Grow t h Driven by Young Firm s d ion Overall t hare of Annualize S ry st Job Crea u d ion t a d Kauffman Foun In 02 4 6 810 18 12 14 16 u s S ion by Young Firm ry st t d In hare of Job Crea Figure 9. Source: Special Tabulation. and oldest companies, represented as the far right settles. Through expansion and recession, companies of all sizes are creating and destroying millions of column in these charts, still matter for job growth, jobs, and employees are leaving and joining (and accounting for over 10 percent of net job creation. starting) firms by the millions, in any year. To say Companies less than five years old, generally small- that Company A created one hundred jobs in a year and medium-sized, join together with gigantic while Company B lost (or destroyed) one hundred mature firms to expand employment. What this jobs doesn’t mean the employment pool at each seems to be suggesting is a symbiotic relationship. company was static. Company A likely destroyed When we talk about net job creation, we mean plenty of jobs while Company B likely created plenty the number of newly created jobs left once the dust of jobs—at the end of the year, the net change is positive or negative. Yet when we look at our of hirings and firings and voluntary separations Kauffman Foundation Research Series: Firm Formation and Economic Growth | Where Will The Jobs Come From 9 February 25, 2010 10:28:43 53056_Kauffman_vers1.pdf 11

12 53056_Kauffman_vers1:1 2/25/10 9:53 AM Page 10 Symbiosis, Churn, and the Wave Effect sectoral cross-section of job creation, we find that by add net jobs is to acquire the younger companies and large those sectors with the greatest share of that are not only generating jobs, but also are employment in large companies (10,000+ responsible for a good number of innovations that employees) were not those sectors with the highest will keep the bigger company’s revenue growth from shares of net job creation. diminishing. The U.S. economy supports an ongoing process of new firm creation, scale growth in some This pattern is not explained by the size of such cases, another round of new firm creation, and companies: the average number of jobs created at selective acquisitions of new firms by those these large firms is understandably big because they companies that achieved scale. It remains the case hire in large batches. Instead, Figure 10 reflects the that young firms drive job creation—many of them huge number of young companies being formed in are simply acquired at a young age by older and other sectors and adding more jobs. Remember, the larger companies, a process seemingly reflected in average young company only adds about four jobs per year, meaning it takes a lot of young companies positive net job creation for those established firms. to add up to a bigger amount of job creation than Without more detailed data, a firm conclusion as to the largest firms. How, then, can we explain the this dynamic eludes us; yet we suspect that such a apparent finding in Figures 3, 4, and 5 that the process (among many) is at work. Anecdotally, at biggest and oldest companies have positive rates of least, we see evidence of this in the acquisition net job creation? strategies of companies such as Cisco and Medtronic, who rely on younger companies to The nature of these data is such that we cannot pioneer innovations (and create jobs), at which point break out mergers and acquisitions, but we suspect they purchase them. And, a good number of that the net addition of jobs in larger companies 14 venture capital-backed companies have their “exit” comes from their symbiosis with younger firms. in the form of acquisition. Such dynamism in the Namely, one of the only ways for big companies to Figure 10: S ec t or s wi t h Highe st are S hare of Em p loymen t in Bigge st Com p anie s Ne st h Bigge t ion ec t Job Crea t No t t he S wi t or s ion a d Kauffman Foun t s s e g s s e s t d st ie ail ale a ion t ion t t s erv erv Mfg t st ili S S Wh t Re of Co Wa h Care urance Mining ruc t t ci/Tech U s d uc sp S st her d t Whole E Real E Heal O Informa Mgm Tran Con Accom Foo Prof/ min an d A Finance In Figure 10. Authors’ calculations from Special Tabulation and U.S. Census Bureau, Statistics of U.S. Business. 14. See, e.g., CARL J. SCHRAMM, THE ENTREPRENEURIAL IMPERATIVE (2006). We may also be seeing an effect due entirely to one sect or—retail—which has both a high share of job creation and a greater number of giant companies than other sectors with comparable job creation numbers. T hat is, the finding that big and mature companies can still produce positive rates of net job creation could be a function of the size and firm composition of t he retail sector, absent which this category of firms would show negative net job creation. This is an issue we will take up in subsequent papers. Kauffman Foundation Research Series: Firm Formation and Economic Growth | Where Will The Jobs Come From 10 February 25, 2010 10:28:43 53056_Kauffman_vers1.pdf 12

13 53056_Kauffman_vers1:1 2/25/10 9:53 AM Page 11 Symbiosis, Churn, and the Wave Effect s Figure 11: Ne t Job Crea t ion for t he Fa st e st -Growing Young Firm ize S by t Percen t ion a d Kauffman Foun 0 o 4 o 9 o 99 t o 19 o 49 t t t t o 999 o 499 o 249 t t t o 4,999 o 2,499 o 9,999 t t t b. 1 c. 5 . 10 f. 50 m. 10,000+ e. 20 d i. 500 g. 100 h. 250 j. 1,000 l. 5,000 k. 2,500 ize S Firm Figure 11. Percent of Annualized Net Job Creation for Top Performing Young Firms. Source: Special Tabulation. have even closed (or been acquired). This becomes capital markets (among mid-size companies as well) is an area deserving of further research. especially apparent when we look only at the fastest-growing young firms in 2007, the top This symbiosis that we suggest highlights a second 5 percent of young job creators. feature of job creation: there is a considerable amount of churn among young firms. Job creation, Figure 11 excludes one- and two-year-old firms, so as noted above, is not a smooth process, and this is we are looking only at firms aged three to five years, especially true for those companies that are those creating the most jobs, on average twenty-six responsible for it. Indeed, young firms have the per year—or seventy-eight to 130 over a five-year highest rates of job creation and job destruction. span. And indeed we see that when displayed by Some young firms, meanwhile, will survive to age firm size, these young companies have grown into nine or ten, and then shed many of the jobs they much larger companies, in some cases employing created. Others will create dozens of new jobs in thousands of people. Importantly, these companies years one and two, only to see them disappear in could still fail at some subsequent point or be years three and four. Most findings on survival rates acquired by older and larger companies; or they indicate that roughly a third of new firms fail to could stop growing and remain the same size survive to age two. When we talk about young indefinitely. Some of these firms, meanwhile, firms, then, we’re talking about an ever-changing continue to generate positive rates of net job assortment of dynamic firms—entering and exiting; creation at older ages—recall Figures 3 and 4, in creating and destroying jobs. Such messiness is not which firms aged six to ten years show up as a cause for dismay or alarm; it is the provenance of considerable source of jobs (at least relative to older net job creation. If we want to chart a rapid age categories). As will be explored in later reports, employment recovery, we need to foster such this can likely be explained by the presence of these messy dynamism. fast-growing companies that continue to create jobs The third implication follows from this churn of past the age five threshold. jobs and firms: a snapshot of any given year’s What does all this add up to? Out of each pool of employment distribution fails to convey the wave- new companies, some emerge to create lots of jobs like movement of firms, particularly new firms, and are succeeded over the next year or next two through time. When talking about job creation, we years by an entirely new pool of firms. The net effect are unavoidably talking about the in-and-out of all this is to consistently add roughly two million dynamic of new and young companies (as well as new jobs to the economy every year, assuming the more established companies, which occasionally fail demand to support their output exists. The economy as well). Firms creating jobs in a two-year period generates a wave effect of new companies and new won’t necessarily be the same companies creating jobs in the subsequent two-year period—and may jobs each year. Kauffman Foundation Research Series: Firm Formation and Economic Growth | Where Will The Jobs Come From 11 February 25, 2010 10:28:43 53056_Kauffman_vers1.pdf 13

14 53056_Kauffman_vers1:1 2/25/10 9:53 AM Page 12 Entrepreneurs=Recovery bolder policy action would be to grant a payroll tax Entrepreneurs = Recovery holiday for new and young companies, thus If the pessimistic forecasts for how long it will take fostering job creation. Such a step would not be the United States to recover from the current without difficulties (it would temporarily add to the employment shock are even in the ballpark, we deficit and might create a payroll tax ceiling beyond could well be facing a long and slow economic which companies hesitate to cross), but would serve recovery in which employment lags behind most as a signal that the U.S. economy, searching for a other indicators. There are various reasons, too, to path to recovery, is open for (new) businesses. think that the severity and nature of this recession Still, virtually all of the attention among could seriously dampen new firm formation. If policymakers and the media has focused on the existing companies see little reason to expand their waiting game by larger firms, currently reluctant to workforce—after all, productivity is rising—why take back employees they dismissed, and unwilling should anyone see fit to start a new company? In a so far to begin hiring new employees again. The darker vein, will companies formed in this recession analysis here, however, suggests this attention is be somehow weaker and more prone to failure? We misplaced. The overwhelming source of new jobs is have also seen a sharp contraction in credit, new firms. The key implication for policymakers particularly commercial loans which, at the time of concerned about restarting America’s job engine, writing, showed few signs of recovering. Credit is therefore, is to begin paying more attention to oxygen for new and young firms and, if loans are removing roadblocks to entrepreneurs who will lead scarce and if household wealth (a big source of us out of our current (well-founded) pessimism financing) has fallen, will new companies be able to about jobs and sustain economic expansion over the raise money? longer run. This much-needed shift in focus cannot These are important questions, not to be taken come soon enough. lightly, and they highlight the need to better understand the dynamics of firm formation, particularly in a macroeconomic and historical context. It could be the case, for example, that this recession opens up opportunities for massive amounts of reallocation—some see this underway already in the auto industry and among those laid off in that industry. “Too big to fail,” once a rough guideline for policymakers, has become a lightning rod for public opprobrium. It could be the case that the cachet of large organizations has taken an irreparable blow as people seek more security in younger and smaller companies. The slow recovery of employment may also work to spur even higher rates of firm formation: instead of waiting around for new jobs, people may take their future into their own hands. To encourage new business creation, there are affirmative steps that can be taken, and negative steps that should be avoided. For example, with credit scarce, government at all levels may be able to help loosen the financing spigots. President Obama announced just this sort of step in October by raising the ceiling on SBA loan guarantees, and extending cheap credit to community banks willing 15 A much to use it to make more business loans. 5 S e e H e n r y J . P u l i z z i , O a . m a A n n o u n c e s S t e p s t o C h a n n e l L o a n s t o S m a l l B u s i n e s s e s , W A L L S T R E E T J O U R N A L , O c t . 2 1 , 2 0 0 9 , a t 1 b http://online.wsj.com/article/SB125615610024099681.html. Kauffman Foundation Research Series: Firm Formation and Economic Growth | Where Will The Jobs Come From 12 February 25, 2010 10:28:44 53056_Kauffman_vers1.pdf 14

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