Just How Important Are New Businesses?

New businesses create most of the new jobs in the U.S. economy each year — not small businesses, as popular wisdom holds. It may thus seem troubling that business formation has not kept up with overall growth in the U.S. economy over the last 35 years. And while counting jobs is just one way to quantify the success of new businesses, their relative decline matters not only for their owners and employees. That’s because even though many new businesses fail, some survivors are innovators and grow rapidly, raising wage growth and productivity across the economy.

But we should be careful not to read too much into the drop in the headline numbers. The economic theory of creative destruction suggests that the success of new businesses comes at a cost to existing businesses.¹ Also, as I will show, Americans seem as entrepreneurial today as they were 20 years ago. Much of the fluctuation in the success of new businesses may actually have been driven by economywide forces such as demographics or technological opportunities, and not necessarily vice versa. So, even though it would be good to reverse the relative trend decline in business formation, it might not be as consequential as some believe.

This article appeared in the Fourth Quarter 2016 edition of Economic Insights. Download and read the full issue.

^[1]Shigeru Fujita’s Business Review article provides an overview of studies quantifying economist Joseph Schumpeter’s famous insight that the continual churn of firm formations and failures is the “essential fact about capitalism.”