Archive for October, 2010

The Role of Startups in Job Creation and Destruction

By Christine Hamilton-Pennell
Growing Local Economies, Inc.

Lately, there has been a spate of new research reports from the Kauffman Foundation, Small Business Administration, and other sources focusing on the crucial role start-up companies play in job creation and destruction.

A recent Kauffman study by Tim Kane, for example, uses Business Dynamics Statistics, a new dataset from the U.S. government, to show that “startups aren’t everything when it comes to job growth. They’re the only thing.”

The data examined indicate that “startup firms are responsible for all net job creation du ring most years, while existing firms (aged one year and older) are usually net job losers.” New firms add an average of 3 million jobs in their first year, while older companies (of all ages) lose 1 million jobs annually.

Startups are defined as companies within their first year of operation, while existing companies refer to those that have been in operation for at least one year. By definition, startups can create jobs but can’t lose them.

Kane’s study focuses on firms rather than establishments, which is an important distinction when drawing conclusions from different datasets. A firm may have multiple establishments in different locations, while an establishment refers to a business in a single physical location.

A further clarification is that the definition of “existing” firms includes both firms that go out of business (deaths) and continuing firms. Kane’s study focuses on survivors. He points out that if business deaths are removed from the equation, survivors, as a group, usually create more net jobs than startups. Fast growing firms (gazelles) are particularly important in this regard.

Another recent Kauffman report, Where Will the Jobs Come From?, further refines these conclusions. Authors Litan and Stangler analyze Census data, which reveals that two-thirds of new job growth comes from firms that are between one and five years old. Job creation comes from three sources: startups; young firms, ages one to five; and the largest and oldest companies. They state that “new and young companies and the entrepreneurs that create them are the engines of job creation and eventual economic recovery.”

The authors conclude that “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.”

The rate of job creation and destruction is influenced by the “churn” of business starts and deaths in a given year. According to data provided by the Small Business Administration, 552,600 new firms started in 2009, while 660,900 firms closed. During the recession, more total firms have closed than opened.

On the other hand, the Kauffman Index of Entrepreneurial Activity indicates that start-up rates among the self-employed are at their highest level in 14 years. An SBA study shows that the start-up rates for nonemployer firms (the self-employed) are countercyclical to the current recession. Self-employment is more often an occupational decision and is correlated with state unemployment rates. The decision to create an employer firm, on the other hand, is more often based on economic opportunity, and is correlated to state real GDP.

How does the job creation provided by start-ups endure over time? Another Kauffman Foundation study by Michael Horrell and Robert Litan analyzes the BDS data for cohorts of firms from 1977-2000. They conclude the following:

• Startups retain, on average, 80 percent of their initial total employment to age five.
• Startups initially hire fewer people during a recession, but catch back up to the same levels of employment at age five.
• Prolonged recessions appear to lower employment among startups.

The research presented above points to the role startups and young companies can play in creating new employment. This does not tell the whole story, of course. For one thing, there is no agreed-upon definition of startups. There is also a difference among data sources as to whether nonemployer firms (i.e., sole proprietors) are included in the datasets. In addition, these studies do not address the quality and sustainability of the jobs created by startups. More research is certainly needed on the dynamics of job growth over time among employer firms. In the meantime, entrepreneurship support organizations and policymakers need to consider the role that startups can play in developing their ongoing strategies for economic recovery and growth.

(In another blog article I have synthesized available research to identify what appears to be the ideal target audience for an economic gardening program, Reflections on the Ideal Economic Gardening Audience.)

Sources:

Kane, Tim. “The Importance of Startups in Job Creation and Job Destruction,” Ewing Marion Kauffman Foundation, July 2010, http://www.kauffman.org/research-and-policy/the-importance-of-startups-in-job-creation-and-job-desctruction.aspx.

Stangler, Dale and Robert E. Litan, “Where Will the Jobs Come From?” Ewing Marion Kauffman Foundation, November 2009, http://www.kauffman.org/research-and-policy/where-will-the-jobs-come-from.aspx.

Small Business Administration. Office of Advocacy. Frequently Asked Questions, 2010, http://web.sba.gov/faqs/faqIndexAll.cfm?areaid=24.

Kauffman Index of Entrepreneurial Activity: 1996-2000.  Ewing Marion Kauffman Foundation, 2010, http://www.kauffman.org/research-and-policy/kauffman-index-of-entrepreneurial-activity.aspx.

Acs, Zoltan, Brian Headd, and Hezekiah Agwara, “The Nonemployer Start-up Puzzle.” SBA Small Business Research Summary, 2009, http://www.sba.gov/advo/research/wkpapers.html.

Horrell, Michael  and Robert Litan, “After Inception: How Enduring is Job Creation by Startups?” Ewing Marion Kauffman Foundation, July 2010, http://www.kauffman.org/research-and-policy/after-inception-how-enduring-is-job-creation-by-startups.aspx.

©Christine Hamilton-Pennell 2010, Growing Local Economies, Inc.

 

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