Why Has Job Growth Been So Slow? Fewer New Businesses

The rate of job creation over the past three years has been disappointing.  The Obama administration touts the fact that private sector employment has increased for 29 straight months.  But since February of 2010, when employment started to rebound, we have added 138,000 jobs per month (an annual growth rate of 1.27%).  Both parties agree that this is insufficient given the depth of the recession and the millions of unemployed, underemployed and discouraged workers in our economy.  An important reason for the disappointing growth in jobs is the slowdown in job creation from start-ups and new establishments.  The U.S. economy would create 2.65 million more jobs per year if new businesses were creating jobs at the same rate as in the 1990’s.

In 2011, for the first time in the 20 years that the Bureau of Labor Statistics has maintained these data, the number of jobs created at new establishments dropped below 5 million.  Job growth from newly formed establishments has declined by 38% since 1998, relative to total private sector employment.  In 2011 jobs created in new establishments accounted for 4.6% of private sector employment compared to 7.4%  of employment in 1998.  The decline in the share of jobs from new establishments has been steady over the past decade as shown by the following graph:

The dearth of start-ups is an important factor in understanding the anemic job growth in this recovery.  If new establishments were being formed at the same rate as in the 1990’s, the U.S. economy would be creating 221,000 more jobs per month (2.65 million more jobs per year).  Job creation would be 160% higher if job gains from new enterprises returned to the rates experienced in the 1990’s.

It is not clear why job growth from new establishments has dropped steadily over the past decade.  It is possible that each new business venture today creates fewer jobs in the U.S. due to outsourcing and technological change.  Regardless of the causes, job growth will not be robust as long as start-ups create fewer and fewer new jobs each year.  Changes in tax policy and regulations to create a business environment amenable for new businesses, that have historically been the engine of job creation, could help reverse this trend.

Jobs, Autos and Krugman

Paul Krugman wrote a thought-provoking opinion piece in last week’s New York Times calling the auto industry bailout “the single most successful policy initiative of recent years.”  Krugman, an expert in the area of economic geography, wrote that “companies that make a large contribution to a nation’s economy — don’t exist in isolation. Prosperity depends on the synergy between companies, on the cluster, not the individual entrepreneur.”  He pointed out that successful manufacturing companies in China and Germany locate near specialized suppliers and specialized labor.  Krugman used this clustering argument to justify Federal help for Michigan automakers: “If G.M. and Chrysler had been allowed to go under, they would probably have taken much of the supply chain with them.”  In effect, he stood the infant-industry argument on its head and argued that large and previously successful companies should be bailed out even if they squandered the advantages provided by their economic cluster.

Foreign Automakers Have Avoided Michigan Despite the Synergies from Economic Clusters 

Over the past two decades foreign automakers located production facilities in Alabama, South Carolina, Mississippi and Tennessee even though these states lacked the clusters and synergies that should have made Michigan an ideal destination.  Michigan failed to attract new investment in auto manufacturing despite their experienced labor force and convenient supply chain.  According to the BLS, employment in motor vehicle manufacturing in Michigan fell by 68% between 1973 and 2011 but increased in the rest of the United States.  Economic clusters are important, but they aren’t enough to offset high marginal tax rates and labor laws that businesses view as unfriendly.

Large Companies Generally Grow More Slowly and Create Fewer Jobs

Krugman’s opinion piece was also meant to be a rejection of Governor Mitch Daniel’s claim that Steve Jobs was a big job creator.  Once a company becomes large and successful its rate of job creation generally slows.  Fortune’s list of the 50 largest companies in 1996 (based on 1995 revenue) includes a number of companies deemed “too big to fail”, including General Motors (1^st), Chrysler (9^th), Citicorp (19^th), AIG (25^th), Fannie Mae (32^nd), Merrill Lynch (33^rd) and Bank of America (37^th).  Apart from Walmart, which tripled the size of its workforce in the past 15 years, the rest of the Fortune 50 employed fewer workers worldwide in 2010 than they did in 1995.  Apple (which ranked 114 on Fortune’s 1996 list) also tripled the size of its workforce between 1995 and 2010.

Jobs are Created in Start-Ups and Young Businesses

The research of John Haltiwanger and co-authors has shown that jobs are created by young businesses and start-ups.  Many of these start-ups will fail, but the successful ones will create new products using new technologies and account for a substantial proportion of net job creation.  Entrepreneurs, innovators and risk-takers are important for job and productivity growth.   High marginal tax rates, that discourage investment in human and physical capital, will lower the rate of job creation by young businesses that are not yet “too big to fail.”