WACO, Texas – Every year, hundreds of thousands of new businesses are launched across the United States, generating an important source of jobs and economic activity.

While many of these don’t survive, the constant introduction of new firms, new ideas, and new opportunities is vital to continued economic success. However, recently released data indicate that the rate of business formation has slowed.

One study from The Brookings Institution described the decline of entrepreneurial activity in America, noting that it was affecting virtually all geographic areas and industries. Researchers looked at business dynamism (the ongoing process of firm creation, failure, expansion, and contraction) and found that it is decreasing. Over the past 20 years, they found lower firm entry rates and less job reallocation based on an analysis of data maintained by the Census Bureau.

The firm entry rate is simply new firms (those less than one year old) as a percent of all firms. That rate fell by nearly half, the authors note, between 1978 and 2011. There are two things I’d like to point out about this dataset and timeframe, however, which help explain this alarming decrease. Naturally, as the U.S. economy has added firms over three decades, it takes more new entrants to keep the proportion the same. In fact, a chart of actual firm entrants by number (not percentage) shows a fairly predictable pattern: up when the economy is growing and down when it’s not, but bouncing around 500,000 per year. This chart, located in the appendix to The Brookings Institution study, also illustrates another point about the dataset; it ends in March 2011.

The effects of the recession on firm creation are very clear (and, again, not surprising) with Census Bureau figures indicating a large drop in the number of new establishments from a peak in 2006 at nearly 831,700 down to just over 609,300 in 2009. By 2011, new establishments were back up to almost 682,800. (As a side note, these statistics differentiate between firms and establishments. If a company has operations in more than one site, it counts as one firm, but multiple establishments.)

M. Ray Perryman
M. Ray Perryman

Unfortunately, since 2011 is the most recent data released by the Census Bureau, the extent of recovery in firm creation over the past few years remains to be seen. I would suspect that, if it is anything like other statistics, it’s been on the rise of late, but may not have reached the level prior to the recession quite yet. While the numbers of new establishments were down virtually everywhere, some geographic areas (including Texas) were doing better than most.

A different index of entrepreneurial activity is tracked by the Ewing Marion Kauffman Foundation. This index also uses data from the Census Bureau, but focuses on the Current Population Survey which is released monthly.  The Kauffman Index looks at data for all individuals aged 20 to 64 who do not own a business as their main job. The following month, they look at whether these individuals now own a business and work at it 15 hours per week or more. Advantages of this index are that it is more timely (the latest release is for 2013), includes more types of businesses, and provides more information on the people creating them. Moreover, it differentiates businesses started by people who are already employed (who presumably see an opportunity and act on it) from those coming out of unemployment (who may be starting a business because they can’t find a job).

As note, the Kauffman Index values reflect the number of adults who have created a business since the last month’s observation. Since 1996, the index has bounced about 0.30 percent, meaning that 300 people of each 100,000 in the Current Population Survey have created a business. The highest measured rates of entrepreneurial activity were during the recession, reaching 0.34 percent in 2009 and 2010. For 2013, the index stood at 0.28 percent. Also, the share of total business creation by people who have jobs (and are taking advantage of opportunities) rose sharply in 2012 as the economy improved.

Another interesting thing about entrepreneurial activity as tracked by the Kauffman Index is that the highest rates of business creation are found in the lower end of educational attainment. People with less than a high school diploma created businesses at a far higher rate (0.48 percent in 2013, down from a peak of 0.59 percent in 2010) than college graduates (0.28 percent in 2013). Note that there are fewer people falling into the less-than-high-school group, so these higher rates don’t necessarily translate into higher absolute numbers.

Many new business ventures are prompted more by a lack of other options than by a desire to seize an opportunity. As the economy improves, it is natural for the rate of formation for such reasons to decline. The Kauffman Index, which is based on survey responses from individuals, reflects that fact; 2012 and 2013 creation rates are down from the recessionary years. The Brookings Institution study looks at entrepreneurial activity from a business standpoint, and found that the proportion of new firms has been falling.  However, the data The Brookings Institution researchers rely on ends in 2011, when the recovery was still very weak. Entrepreneurial activity is essential to long-term prosperity, but recent gloomy headlines may not reflect a truly damaging long-term problem.

<I>Dr. M. Ray Perryman is President and Chief Executive Officer of The Perryman Group (www.perrymangroup.com). He also serves as Institute Distinguished Professor of Economic Theory and Method at the International Institute for Advanced Studies.</I>