By Dane Stangler and Robert Litan Saturday, June 5, 2010
Filed under: Boardroom, Culture, Economic Policy, Public Square
Last month, the Kauffman Foundation released the most recent Index of Entrepreneurial Activity, which tracks monthly business formation in the United States using data from the Census Bureau. Compiled by Professor Robert Fairlie of the University of California-Santa Cruz, the report found that, in 2009, the United States experienced its highest level of entrepreneurial activity in the past 14 years.
While many economists suspect that the recession ended in the summer of 2009, last year was unquestionably sluggish for the American economy. Unemployment, for example, continued to rise throughout the year and, despite positive trends in the past several weeks, will likely remain high for the foreseeable future. Nonetheless—or perhaps predictably—millions of Americans struck out on their own, forming new companies or, in more informal arrangements, shifting to self-employment.
Understandably, this finding has generated considerable interest—the entrepreneurial spirit is apparently alive and well, resilient through even a steep recession. All, however, is not rosy. In a recent New York Times opinion piece, Robert Reich cautioned against celebrating this spike in entrepreneurship, calling it instead a “new wave of involuntary entrepreneurship.” Because unemployment rose so quickly in 2008 and the first half of 2009, Reich argued, many of these entrepreneurs should more properly be seen as desperately self-employed, not “innovative owners of startup businesses.” After all, Reich wrote, “another term for ‘entrepreneur’ is ‘self-employed.’”
Undoubtedly, necessity and desperation lurk somewhere in the Kauffman Index data on entrepreneurial activity—no one would deny that, in the face of persistent unemployment and a slow pickup in hiring, many Americans likely turned to self-employment as a last-ditch measure. The nature of the data makes it difficult to distinguish the “merely” self-employed from those who might meet the conventional definition of an entrepreneur. Still, there are reasons to be more optimistic about the Kauffman Index findings than Reich, who paints a not-quite-accurate picture of firm formation.
First, it simply isn’t true that, as Reich contends, “Usually new businesses take off in good times.” The conventional, though empirically unsupported, wisdom is that recessions suppress new business creation while expansions increase it. Yet data from the Business Dynamics Statistics series show that, since 1977, firm formation in the United States has been remarkably steady, with Kauffman’s data showing annual fluctuations occurring only within a very narrow band of variance. In fact, the late 1990s boom that is remembered as an era of turbo-charged, Internet-fueled entrepreneurship was actually one of the quieter periods of firm formation, whether measured by the rate of entrepreneurship or annual standard deviations from the historical average.
This doesn’t mean entrepreneurship will always be unaffected by swings in the business cycle, but it does mean that, when confronted with evidence that firm formation increased during a recession (or, at least, in a year of recession and recovery), we shouldn’t immediately jump to the conclusion that the uptick was due entirely to desperate entrepreneurs who had no other choice.
Reich’s argument, moreover, reflects a common bias about “true” and “false” entrepreneurs. At a conference we attended a few months ago, two professors of entrepreneurship claimed that, out of the hundreds of thousands of new companies founded each year in the United States, only about a thousand can be considered “real” entrepreneurs that matter for economic growth. So next time you head down to your local coffee shop or grocery store, feel free to let the owners know that they don’t count in the American economy. We need to move past this notion that only companies considered by unanimous consent to be “innovative” or to have emerged from high-technology sectors can be considered entrepreneurial.
We have no idea which companies or self-employed individuals that got their start in 2009 will one day become the next Wal-Mart or Microsoft. Many will fail, to be sure (although failure rates are generally lower than is widely believed). Many will enjoy modest success, and a handful may grow rapidly into the next generation of scale firms. We simply cannot tell at the outset when firms are formed. That someone started their business out of desperation or in the middle of a recession says little about their future prospects for success. But to preliminarily judge them as marginal to the economy does them a disservice and distorts our own entrepreneurial history. Well over half of the companies on the Fortune 500 list, for example, were founded during recessions or bear markets—many of them without dreams of empire-building.
Reich is not all wrong, of course. He promotes the idea of wage or earnings insurance to support the gap between a person’s former earnings and what they earn in self-employment. We also support this idea, especially since once of us (Litan) has been writing about it for nearly 25 years.
In a larger sense, Reich is correct to highlight the shortcomings of any measure of entrepreneurship—firm formation is a slippery topic and, as already indicated, many of the ideas conventionally assumed true have turned out wrong. The findings of the Kauffman Index appear at odds with other entrepreneurship indicators, including those of the Bureau of Labor Statistics and the Organisation for Economic Cooperation and Development, which suggest that entrepreneurship in the United States has actually been falling over the past few years. This doesn’t mean each of these measurements is necessarily wrong, but they do highlight the need for improved research.
As Reich points out, the difference between the Kauffman Index and other datasets might likely exist because Kauffman includes self-employed individuals. But to say that the self-employed are not real entrepreneurs, or should only be considered to be a negative indicator, misses an important dimension of the American economy. Each year, a substantial portion of “new” companies emerge from the population of “nonemployer firms” and self-employed. We should expect that many of those who joined the ranks of the self-employed last year will eventually become employer firms, however large or small. Reich either has incredible powers of clairvoyance or, like many other people (including ourselves), is still in only the early stages of fully understanding the phenomenon of entrepreneurship.
Much work remains to be done, but one thing is for sure: entrepreneurship is never a bad development for the American economy. It is an enduring source of new job creation and innovation. It is quite likely, moreover, that in two or three decades, we will look back on the “Great Recession” of 2007–2009 as not only a traumatic event in the life of our country but also the source of some of the 21st century’s most successful firms—even if they started out in desperation as one self-employed individual.
Robert Litan is vice president of research and policy at the Kauffman Foundation, where Dane Stangler is research manager.
Image by Rob Green/Bergman Group.
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