Sputtering Startups Weigh on U.S. Economic Growth

By JEFFREY SPARSHOTT

Decadeslong slowdown in entrepreneurship underscores transition in American labor market

Attendees work on laptop computers at the TechCrunch Disrupt San Francisco 2016 Summit, a conference for technology startups, on Sept. 12. PHOTO: DAVID PAUL MORRIS/BLOOMBERG NEWS

The U.S. economy is inching along, productivity is flagging and millions of Americans appear locked out of the labor market.

One key factor intertwined with this loss of dynamism: The U.S. is creating startup businesses at historically low rates.

The American economy has long relied on fast-growing young companies to fuel job growth and spread the latest innovations. As recently as the 1980s and 1990s, a small number of young firms disproportionately contributed to U.S. employment growth, helping allocate workers and resources to burgeoning segments of the economy.

But government data shows a decadeslong slowdown in entrepreneurship. The share of private firms less than a year old has dropped from more than 12% during much of the 1980s to only about 8% since 2010. In 2014, the most recent year of data, the startup rate was the second-lowest on record, after 2010, according to Census Bureau figures released last month, so there’s little sign of a postrecession rebound.

The share of employment at such firms, meanwhile, has slipped from nearly 4% to about 2% of private-sector jobs.

While only a few percentage points, the drop translates into hundreds of thousands of companies and jobs. If the U.S. were creating new firms at the same rate as in the 1980s, that would be the equivalent of more than 200,000 companies and 1.8 million jobs a year.

“The U.S. is still a robust economy,” said John Haltiwanger, a University of Maryland economist who has written extensively on startups. “It’s still a place that is more dynamic, more flexible, more entrepreneurial than many economies around the world. But it’s not what it used to be.”

The startup slowdown may have a number of causes. Perhaps some companies need more time than backers are willing to provide. Demographics may also explain some of the shift—baby boomers are retiring and millennials are just entering the age bracket that is most common for entrepreneurs.

Rules and regulations also could be at play. Goldman Sachs economists in part blame the cumulative effect of regulations enacted since the Great Recession for reducing the availability of credit and raising the cost of doing business for small firms, making them less competitive.

To be sure, the economy has been advancing and the labor market adding jobs for years. But the pace of this expansion has been the weakest since at least World War II, with gross domestic product growing at a 2.1% annual rate since mid-2009. GDP figures for the third quarter are due Friday and are expected to be only a little better. Economists surveyed by The Wall Street Journal are forecasting a 2.5% pace.

Meanwhile, job creation has shifted more toward incumbent firms, a development that appears interrelated with a handful of other phenomena, including the drop-off in labor productivity, less churn in the labor market, the dominance of fewer, bigger companies and a geographical concentration of dynamic startups into fewer cities.

It’s also likely one reason the recovery from the Great Recession was so protracted—and could portend another slow comeback from the next downturn. The White House in its latest annual economic report highlighted the decline in startups since the 1980s. “Young firms that survive grow faster than older, established firms,” the report said. “Having fewer young firms thus delays recovery after recessions.”

With fewer new companies, it also becomes harder for workers to find jobs best matched to their skills and lowers overall productivity, the White House said.

Indeed, U.S. labor productivity growth has been deteriorating for more than a decade. Productivity is a key to higher living standards, allowing wage gains without spurring inflation.

There is some disagreement on whether tech firms have fallen into the same doldrums as other startups like mom-and-pop shops. Mr. Haltiwanger and colleagues at the Federal Reserve and Census Bureau find evidence they have, with significant detriment to the economy.

“It may be that we are designing things here in the U.S. as rapidly as ever,” Mr. Haltiwanger said. “We’re just not producing here. That’s not good news for U.S. productivity.”

Researchers at the Massachusetts Institute of Technology delved into state business licensing information and found somewhat different but also discouraging results. That is, tech entrepreneurs are generating good ideas and founding companies at a healthy pace, but those ventures aren’t breaking out into successful big companies.

“The system for translating good, high-quality foundings into a growth firm, that system seems to have broken,” said Scott Stern, an MIT professor and co-author of the study on startups.

CB Insights tracked 1,027 tech companies that received seed funding in 2009 and 2010. By the end of 2015, nine—fewer than 1%—reached a value of at least $1 billion, a common measure of success. Those include Instagram, Uber and Slack.

At least for now, those companies appear more the exception than the rule.

Write to Jeffrey Sparshott at jeffrey.sparshott@wsj.com

Original