Business Dynamics in the Fifth District

The dynamics of firm creation and exit are an important engine of economic growth. Entrepreneurs identify an opportunity, enter the market, and increase competition by offering new goods and services. In the process, they add to the demand for labor, make investments in equipment and software, and contract for services from other businesses.

At the same time, some businesses become obsolete either because consumers are no longer interested in their products or services or because their competitors are able to offer a higher-quality product or service or a lower price; in such cases, the firms exit and the resources they utilized, such as labor, are then freed to be used by more productive firms. Studies have shown a prominent role of business startups in job growth and have found a positive relationship between entry and exit and productivity growth.

Researchers have noted that there has been a slowing in business dynamics in the United States in recent decades. Job creation and job destruction rates have declined since the late 1970s, and net job creation has trended lower as well. Lower business startup activity is one of the factors responsible for this slowdown.

The rate at which new firms are created has declined since the late 1970s, and their contribution to employment growth has decreased as well. The Great Recession of 2007-2009 further contributed to this decline; job creation and destruction rates, as well as new business formation, dropped sharply and have remained at levels well below those prior to the recession.

Declining startup activity has hurt job growth. In a 2010 National Bureau of Economic Research working paper, John Haltiwanger of the University of Maryland and Ron Jarmin and Javier Miranda of the Census Bureau found that "firm births contribute substantially to both gross and net job creation" and that startups play a "critical role" in U.S. employment growth dynamics.

For those startups and younger firms that survive, their growth rate is considerably higher than that of more mature firms. In Haltiwanger, Jarmin and Miranda's paper, they found that business startups account for roughly 3 percent of total employment in any year from 1992 to 2005. But that percentage was higher prior to 1992, averaging close to 4 percent prior and averaging just 2 percent from 2006 to 2014.

Slowdown in the Fifth District

The Fifth District has experienced trends in business dynamics and startup activity similar to those of the nation. (See chart below.) The new firm formation rate for the Fifth District was only 0.4 percentage point lower than that of the nation in the 1980s and 1990s and 0.6 and 0.8 percentage point lower in the 2000s and 2010-2014, respectively. Among Fifth District jurisdictions, North Carolina, Virginia, and South Carolina have had the strongest startup rates, followed by Maryland and then West Virginia and the District of Columbia (click on the state names in the chart legend to add them to the chart).

The startup rates for North and South Carolina and Virginia have been fairly close since 1980, with the period averages usually within a few tenths of a percentage point of one another. The District of Columbia has historically had the lowest startup rate until 2010-2014 when the West Virginia rate dropped a full 2 percentage points from the 2000s to a low of 5.4 percent.

The decline in startup activity and job creation has been fairly uniform across the Fifth District. From the 1980s to 2010-2014, the decrease in startup activity in the Fifth District was 4.9 percentage points (comparing period averages), slightly greater than the 4.4 percentage point drop for the United States.

Most Fifth District jurisdictions experienced a decline close to the district average, with South Carolina having the greatest at 5.2 percentage points, although Maryland, Virginia, and West Virginia were only slightly smaller. Startup activity declined the least in the District of Columbia, by 3.5 percentage points.

As would be expected, the decline in startup activity was reflected in job creation. The percentage of employment created by new firms in the Fifth District fell from 3.3 percent in the 1980s, just slightly less than the U.S. rate of 3.6 percent, to 1.8 percent in 2010-2014.

Although there was a moderate upward trend in the absolute number of jobs created by new firms from the 1980s through the mid- 2000s (from 245,000 in the 1980s to 275,000 in the 2000s and peaking at 322,000 in 2006), the increase did not match the growth in overall employment, so the job creation rate by startups slowed each decade before dropping after the Great Recession (to an average of 203,000 in 2010-2014).

There was notable variation in the decline in the new firm job creation rate across the Fifth District. From the 1980s to 2010-2014, the number of new jobs created declined by 17 percent — a 1.5 percentage point decline in the new firm job creation rate.

West Virginia, the District of Columbia, and Maryland experienced larger decreases of 37, 34, and 27 percent, respectively, while North Carolina had the smallest change, 4.4 percent, or just a 1.1 percentage point decline in the new firm job creation rate.

Conclusion

Over the last several decades, the rate which jobs are created and destroyed has diminished and fewer new firms are created each year. This slowing in business dynamics is taking place in the Fifth District and across all industry sectors.

Research has highlighted the recent trends and has offered some insights into factors that may be impacting firm entry and exit, entrepreneurship, and business dynamics more broadly, but there has yet to be a definitive accounting of the current trends. The Great Recession accentuated the slowdown and new startups and job creation from new firms remain well below pre-recession levels.

This report contains excerpts from a recent Econ Focus article, which can be found here.

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Views expressed are those of the authors and do not necessarily reflect those of the Federal Reserve Bank of Richmond or the Federal Reserve System.