The hardest thing to get used to when we started the Delaware Small Business Development Center at the University of Delaware was business clients who ultimately had to shut-down.
Over time, however, one came to realize that most businesses closed for sound reasons: a change in technology (8 track tapes vs. CDs), more efficient and convenient competition (Borders vs. Amazon), and simply changes in consumer tastes and preference.
Economists call this process of business coming and going “churning.” The “churning” process is essential to economic growth. Extensive research shows that exiting businesses are less productive than surviving businesses and that younger businesses tend to have higher productivity gains than more mature businesses.
Over time a healthy economy should be moving from less productive to more productive businesses and industries.
Recent research from the Brookings Institute (May 2014, Hathaway and Litan), using Business Dynamics Statistics data from the Bureau of Census, clearly evidences a sharp decline in the business dynamism of the nation’s economy since 1980, primarily due to a steep drop in the entry rate of new firms.
Using the same data base, a similar pattern is found for Delaware.
The Federal government tracks the entry and exit of both firms and establishments. The distinction between the two is important. An establishment is a single physical location where economic activity takes place. A firm, on the other hand, is economic activity, including many establishments, occurring under common operational control. The closing of a WalMart in Delaware, for example, would constitute the exit of an establishment but not count as the loss of a firm.
The coming and going of firms is of more consequence than the coming and going of establishments.
The graph below shows the firm entry and exit rates for Delaware since 1980. A number of things jump out. First, the annual entry rate of firms into Delaware’s economy has dropped, going from over 12% to about 7%. This is a substantial decline in the dynamic change that annually restructures the state’s economy.
Second, the firm entry rate has dropped precipitously since 2006, the beginning of the recent recession. And since 2009, for the firm time in the 30 years of the data, the entry rate has fallen below the exit rate. Fewer firms are now replacing the steady stream of firms that leave Delaware’s economy each year.
The decline in business dynamism is not isolated to Delaware. It extends across all regions of the nation, and all industrial sectors and firm sizes. Apparently there is a strong move toward business consolidation occurring in the U.S. as large box stores replace local “Mom and Pop” businesses and chain restaurants drive out local eating places. Firms and individuals also appear to be more risk averse: hanging on to cash, less willing to launch a new firm, and more likely to stay in the current job and location.
CONCLUSION
If an economy becomes less dynamic, productivity does not increase and the rate of job creation lags. What can be done to counter this? At the least government can make the licensing and regulatory hurdles to business firm entry as low as possible. Taxes, grants and regulations can encourage an increase in the supply of business incubators and accelerators that provide lower overhead costs to start-ups and opportunities for mentorship.
The constant reallocation of capital and resources among firms and industries is essential to sustaining economic growth and raising the standard of living.
Dr. John E. Stapleford, Principal
DECON First uses economics to strengthen Delaware business. This is accomplished by providing accurate, objective, and relevant analysis of the economy, coupled with best practice recommendations that deliver new customers. The detailed analysis for the Indicators above is found in the DECON First Quarterly Delaware Economic Review
