The great start-up slowdown

The great start-up slowdown

Some economists see a link between the scarcity of start-ups and the rise in influence-peddling

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Published on December 17, 2014

PHOENIX — Usually on Fridays, Heather Jackson drives to the Palo Verde Nuclear Generation Plant, where she’s a physicist, and she works a 10-hour shift. One particular Friday she asked for the day off. The time had come to do something about her shoes.

All day she read market research and wrote her pitch. She pulled on size-10.5 brown boots with squared, scuffed toes. She drove across town to a cinder-block office with bare concrete floors, where 50 people with hopes of starting their own companies had gathered for the weekend. She found a white plastic chair, watched several men speak for a minute each and then walked to the front of the room. Her hands shook.

Then she told them her idea.

“Raise your hand if you or someone you love has trouble finding shoes that fit,” she said. She raised her own hand and watched several others do the same, then added, with a smile, “Look around at my target customers.”

ABOUT THIS SERIES:  The American middle class is floundering, and it has been for decades. The Post examines the mystery of what’s gone wrong and shows what the country must focus on to get the economy working for everyone again.

Chapter 1: Why America’s middle class is lost
Chapter 2: The devaluation of the American middle class
Chapter 3: The college trap that keeps people poor
Chapter 4: A black hole for our best and brightest
Chapter 6: What went wrong, and how to fix it

Jackson was taking a risk, identifying a problem and trying to launch a new business to solve it. A shrinking share of Americans are doing the same.

There are two entrepreneurship problems afflicting the U.S. economy today, and both are bad for the middle class. The country doesn’t have enough of the kind of entrepreneurship that creates jobs, and it has too much of the kind that boosts rich executives at the expense of everyone else. 

Both problems suppress the creation of the sort of jobs and businesses that historically have lifted workers into the middle class.

The more pronounced of those trends is a slowing birthrate for new businesses. The slowdown has persisted over two decades and has worsened since 2000. Economists aren’t entirely sure what’s causing it.

The nation’s “start-up rate,” the number of new companies as a share of total companies, declined by 12 percent from the late 1980s to the eve of the Great Recession. That’s according to research by John Haltiwanger, a pathbreaking University of Maryland economist who studies business dynamics, and several co-authors. They found the rate dropped even further during the recession: By 2011, it was about 25 percent lower than it was in the late ’80s.

Recent research from the Brookings Institution confirms that compared to 25 years ago, a smaller share of Americans today work in start-up companies and that a smaller share of companies are start-ups. Even the tech industry — that bastion of venture capital and IPOs — has seen its start-up rate decline. In 1982, Haltiwanger and coauthors report, 3 in 5 high-tech firms were young start-ups; in 2012, that had fallen to less than 2 in 5.

This is bad for middle-class workers. Newer companies create a lot more jobs, on net, than long-established ones, according to several studies, including a recent one by the Organization for Economic Cooperation and Development, which compiles economic statistics for wealthy nations around the world. (This is true even though so many start-ups fail.) Haltiwanger’s research suggests America would have 1.1 million more jobs today if dynamism were still at even mid-1980s levels. More jobs would reduce competition among would-be workers for available slots, which would mean companies would need to pay workers more to attract or keep them.

You could see the allure of launching a business — and the long odds facing entrepreneurs — by following Jackson through Startup Weekend Phoenix, a 54-hour marathon run by an altruistic group of techies, where participants dream up companies, flesh out the concept and pitch them to a panel of judges. Almost everyone came to the event with an idea they were convinced could blossom into the next Facebook or Google, if only they could find the team and the money to bring it to life.

By the second day, 1 in 5 of the participants had quit. Dozens more would shelve their start-up ambitions once they returned home on Sunday night. Jackson was determined to be different. She wanted to win the competition, which came with a prize of work space and business coaching. She wanted it to be a springboard. She was ready to forsake nuclear engineering to run her new company. “I’m totally willing,” she said.

LEFT: From left, Tom Hall, Heather Jackson and Southin Simphoukham pitch their idea to a shopper at a mall in Scottsdale, Ariz., during Startup Weekend Phoenix. RIGHT: Cameron Kashani Rasouli, a global facilitator of Startup Weekend, talks with a client from her shared-workspace company in Santa Monica, Calif.

First, she needed to get a bunch of geeky young men interested in shoes.

Startup Weekend Phoenix was hosted by a company called Coplex, which rents a spartan office space directly under the landing path of the Phoenix airport. A nervous crew filled the space on Friday night: mostly guys, mostly in their 20s, mostly in Converse sneakers, jeans and short sleeves. They drank beer and Red Bull from large picnic coolers, frequently replenished.

One by one they pitched their ideas. An app to see what your friends are wearing today. A dating site that lets friends and family set you up. A Web site to show you whether your dining destination has health-code violations. And Jackson — with her plan to let customers take pictures of their feet with a smartphone, upload them and end up with (relatively) inexpensive pairs of custom-made shoes. She hoped to disrupt the giants of the shoe industry, to democratize form-fitting footwear.

Jackson grew up in a trailer park in a small town in Georgia. Two experiences shaped her entrepreneurial dreams: She watched factory jobs flow from her town to Mexico, and her feet were very wide at the toes but narrow in the heels.

“I’ve been wishing my shoes fit for years,” Jackson said on Saturday at the Startup Weekend, after the crowd had voted to greenlight her idea and she’d assembled a team of techies and marketing whizzes. “I think it’s important to have jobs in America,” she added a moment later. “And not just soul-crushing jobs for The Man — craftsmanship jobs.”

It’s important for the American economy to have start-up companies — and not just so that the owners of those companies can earn their way into the middle class. Start-ups also help oil the engine of capitalism.

Ideally, there’s a sort of natural selection constantly happening in free markets. Weaker, less adaptable firms shrink and fail. Stronger, more innovative ones grow and thrive. Economists call that process “dynamism” or “creative destruction.” Its purpose is to make sure the country is employing people, money and technology in the most efficient way. When someone starts a company that tries to innovate — to sell a better, faster, cheaper way to solve a human problem — economists call that “productive entre­pre­neur­ship” because it helps the whole economy work better.

Today’s economy, though, has lost some of the dynamism it had after World War II, when shared prosperity flourished. Fewer new firms are springing to life, and fewer old firms are failing.

In a recent paper for the Brookings Institution, economists Robert Litan and Ian Hathaway calculate that a third of all U.S. firms were at least 16 years old in 2011. That’s a 50 percent increase from 1992. Nearly three-quarters of all private-sector workers were employed by those firms, up from three-fifths in 1992.

This brings us to the second problem with U.S. entre­pre­neur­ship today: Those older firms appear to be growing more interested in what economist William Baumol called “unproductive entre­pre­neur­ship.”

Put simply, that means companies are ramping up their efforts to win favors from the government — tax breaks, spending contracts or industry regulations that favor their firm over potential competitors. Many economists, such as Luigi Zingales of the University of Chicago, contend those efforts divert resources that could be boosting the economy and sparking more job creation.

From 1998 to the peak of the influence boom in 2010, after adjusting for inflation, American companies nearly doubled the money they spent lobbying federal lawmakers, according to the nonprofit Sunlight Foundation. There’s an index that tracks stock performance of the 50 companies that lobby the most, and in 2012, it outperformed the market as a whole by 30 percent.

A recent study for George Mason University’s Mercatus Center by economists Russell Sobel and Rachel Graefe-Anderson found that for companies, deep political connections (including high lobbying spending) and higher revenues go together. But instead of banking those extra revenues as profits, the firms appear to pass them on to their chief executives. The paper finds “a robust and significant positive relationship between political activity and executive compensation.”

Some economists see a link between the nation’s two entre­pre­neur­ship problems — the scarcity of start-ups and the rise in influence-peddling. By bending tax laws and new regulations to benefit them, those economists theorize, existing companies make it harder for anyone new to challenge for market share. Litan and Hathaway, the authors of the Brookings studies, say that theory would take decades of research to prove or disprove — but that it certainly appears today that established companies have unusual advantages over new companies.

This is another case of some of the country’s most talented people following rational incentives to maximize their own pay at the expense of the economy.

Look at shoes, for example. In December 2012, state lawmakers in Oregon met for a one-day special session. They considered exactly one bill, which they passed and the governor signed. The bill allowed the governor to ink a contract with the state’s most iconic big company, the shoe and apparel giant Nike. The company agreed to create 500 new jobs. The governor agreed to lock in a favorable tax system for Nike for the next 30 years. Any new shoemakers that spring up in the state will need to contend with tax uncertainties that their largest rival won’t be sweating. (Only one other company reached a similar deal: tech giant Intel.)

LEFT: Charlie Rodriguez photographs Southin Simphoukham's foot so he can make a 3-D printout of it during Startup Weekend Phoenix in Tempe, Ariz. RIGHT: The printout of the shoe sits in a 3-D printer at Startup Weekend Phoenix's headquarters.

Jackson wasn’t worried about any established competitors as Startup Weekend hurtled to the final presentation. She and her team were just trying to scrape together a prototype version of their company. They surveyed shoe shoppers at a nearby mall. They fired up a 3-D printer — which one of their engineers happened to be toting around in his car trunk — to churn out a highlighter-green model of a foot. They threw together a PowerPoint presentation. Jackson gave the final pitch.

“No matter what happens,” she said, as the judges deliberated, “I’m moving forward” with the company.

She didn’t win. Three other teams took the weekend’s prizes. Judges urged Jackson to streamline her idea.

She followed the advice. Several months later, she’d focused her efforts on custom-made boots. She was working out of her home, partnering with a local denim company for space and distribution, and writing an e-book on shoemaking.

She was still working at the nuclear plant, but she juggled her schedule to spend Thursdays and Fridays apprenticing with a local bootmaker.

“My passion is to create jobs that people love,” she said. She was still ready to follow that wherever it leads.

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About the series

The American middle class is floundering, and it has been for decades. The Post examines the mystery of what's gone wrong, and shows what the country must focus on to get the economy working for everyone again.