Federal Policies in Response to Declining Entrepreneurship
CBO examines the falloff in entrepreneurship, its potential economic consequences, factors that have contributed to it, and ways that federal policies could be changed to reverse the trend.
Entrepreneurship is beneficial to the economy in many ways. Policymakers may therefore be concerned about its continued decline over the past four decades and the implications for economic growth. In this report, the Congressional Budget Office examines the falloff in entrepreneurship, its potential economic consequences, factors that have contributed to it, and ways that federal policies could be changed to reverse the trend.
How Much Has Entrepreneurship Declined Since the 1980s?
Several measures of entrepreneurship have declined since the early 1980s. The rate at which new businesses formed decreased from 10 percent of all firms that existed in 1982 to 8 percent in 2018. New firms (defined here as those less than five years old with at least one employee on the payroll) constituted 38 percent of all businesses in 1982 but were only 29 percent of them in 2018. During that period, new firms’ share of employment fell by a third, from 14 percent to 9 percent. The decline in new firms’ share of employment was fairly consistent in both the retail and services sectors throughout the period, whereas the share of employment attributed to new businesses in the information and high-tech sectors rose in the 1990s, falling thereafter. Although an early indicator of entrepreneurship—applications for an employer identification number submitted by likely employers to the Internal Revenue Service—dropped precipitously after the start of the 2020 coronavirus pandemic, it subsequently rebounded strongly.
How Has the Decline in Entrepreneurship Affected Productivity Growth?
Entrepreneurship plays an important role in allocating resources more efficiently throughout the economy, thereby making it more productive. Innovative new firms can be a source of technological change, often introducing new products and services. New companies can also increase the productivity of workers by improving methods of production, and they can bring competitive discipline to markets, forcing other companies to become more efficient to maintain business. Even the potential for new firms to enter a market can influence the behavior of existing firms.
The decline in entrepreneurship over roughly the past 40 years appears to have had a moderate impact on the overall growth of productivity. In particular, the decline was related to a falloff in labor productivity of at least 3 percent to 4 percent by the mid-2010s, in CBO’s assessment, compared with what it would have been otherwise. In the 1990s, new firms in the information and high-tech sectors supplied products that were useful to a wide range of industries, and the growth of those firms was accompanied by greater productivity growth in the economy. When the growth of new businesses in those sectors later declined, so did the growth rate of productivity.
The effects of a reduction in entrepreneurship in a given sector of the economy may also depend on the cause underlying the reduction. In some cases, economic forces that led to increases in productivity, such as economies of scale and scope, hampered the formation of successful new firms. For example, technological advances commercialized during the last half of the 1990s enabled large incumbent firms in the retail sector to implement new, more efficient business practices. As a result, the decline in new firms and their employment share in that sector was associated with an increase in productivity growth, as smaller, local retailers could not compete with the large incumbent firms.
What Factors Have Caused a Decline in Entrepreneurship?
Financing constraints and broader economic conditions have played a significant role in the decline of entrepreneurship, particularly in the aftermath of the 2007–2009 recession. New firms are especially vulnerable to economic downturns and the concomitant adverse effects on revenues and bank lending. Although economic uncertainty appeared to hinder entrepreneurship during the first few months of the coronavirus pandemic, the subsequent upswing in applications for employer identification numbers from potential new employers suggests many new firms may have launched in the latter part of 2020.
Demographic trends have also affected entrepreneurship. A decline in the growth of the working-age population, from 3 percent at the end of the 1970s to 1 percent at the end of the 2010s, has been linked to the decrease in new businesses. In addition, people between the ages of 35 and 54 are more likely to be entrepreneurial—and successful in their new businesses—than those of other ages, and their share of the workforce has fallen since 2000. Despite those overall demographic declines, the proportion of foreign-born people among the U.S. population grew from 10 percent in 1998 to 14 percent in 2018. Highly educated, foreign-born workers add to the pool of qualified employees for new firms, especially in the high-tech sector. Immigrants have also been more likely than native-born Americans to start new businesses. Looking forward, CBO expects a substantial drop in net immigration to the United States from 2020 through 2023 because of the coronavirus pandemic.
Regulation affects businesses, but the research literature provides mixed evidence regarding the quantitative impact of the regulatory environment on the formation and growth of new businesses. Some individual regulations discourage the entry of new firms, and some studies show that increases in the overall stringency of federal regulations hamper entrepreneurship, but others do not. The details of the regulations and of the industry setting affect the impact. The patent system generally encourages entrepreneurship by providing a legal framework that protects intellectual property, although large concentrations of patents held by incumbent firms can be a barrier to new businesses. Some economists are becoming concerned about diminished competition among firms—especially those firms involved in Internet-based commerce—and its harm to entrepreneurship, and about the impact of noncompete clauses. Changes in health care policy over the past 40 years have had varying effects. The continuation of group coverage upon separation from employment and an increase in the federal income tax deduction for health insurance provided to the self-employed have made entrepreneurship more attractive for many people than it was at the start of the 1980s. The passage of the Affordable Care Act (ACA) in 2010 made health insurance coverage cheaper and more accessible for some entrepreneurs but more expensive for others.
What Federal Policies Would Support Entrepreneurship?
Federal policies can address many of the factors that inhibit entrepreneurship. Policymakers could create a program to give new firms access to credit. A challenge is that new firms lack a track record demonstrating their ability to repay loans, and roughly half of them will fail within their first five years, on average. Providing them with greater access to credit would entail costs to the federal government and would run the risk of failures; it could also provide an incentive for firms to modify their operations solely to qualify for the subsidized credit. Policymakers could expand the Small Business Administration’s (SBA’s) existing credit programs. The SBA charges borrowers fees that are intended to be large enough to offset losses from loans to small businesses that are not fully repaid, which means that the agency has a limited ability to take risks on new firms. Expanded SBA lending would also potentially provide benefits to small businesses that are not new ones. Although virtually all new firms are small (say, with fewer than 100 employees), only 30 percent of such small businesses are new.
Policymakers could increase financial support for entrepreneurship in several other ways. They could direct a share of the federal government’s spending on research and development (R&D) to be set aside for new companies or increase the existing share provided for small firms. Policymakers could take steps to subsidize products that are more likely to be supplied by cutting-edge new firms, or they could make tax preferences used primarily by small businesses more generous. A drawback to such approaches is that financial support directed to small businesses without regard to their age may not reach many innovative new companies. Moreover, it can be challenging for the government to predict which firms will be innovative and to determine which sectors of the economy to target with support for innovation.
Highly skilled immigrants have founded many companies in the United States that have increased innovation, job creation, and economic growth. Policymakers could support entrepreneurship by expanding programs that provide visas for highly skilled workers and entrepreneurs immigrating to the United States. A challenge here is that expanding the pool of qualified workers through immigration would also entail a broader set of effects on businesses and wages throughout the economy. And programs that attempt to identify immigrant entrepreneurs are costly to administer and susceptible to abuse.
The federal government could make regulatory policies less burdensome for new firms in particular. Policymakers could also increase the scrutiny of incumbent firms’ potentially anticompetitive actions directed toward rival start-ups. Finally, concerns about the impact of diminished competition on the formation and growth of new firms could be addressed by restricting the use of noncompete contracts. The effects of such policy changes on entrepreneurship would depend largely on the details of the policies.