Entrepreneurs and Young Firms Drive Economy

April 11, 2013

For politicians struggling to create the proper policy environment for economic recovery, job creation is the ultimate goal. To understand best how to create more jobs, policymakers must be aware that young start-up firms are the primary driver of job growth and destruction in the U.S. economy, says Salim Furth, a senior policy analyst at the Heritage Foundation.

  • Firms with more than 500 employees provide 45 percent of the jobs in the private non-farm economy.
  • In large firms and industries, more jobs are created, as well as more jobs are destroyed.
  • The constant churn of jobs in the economy is healthy. Between 1975 and 2005, economists reported that gross annual job creation was 17.6 percent and gross annual job destruction was 15.4 percent, resulting in net job creation of 2.2 percent annually.

Politicians frequently claim that small businesses drive a majority of job growth but based upon econometric analysis, the more accurate expression is that young businesses drive growth.

  • Sixty percent of the jobs created by start-ups still exist five years later.
  • Cities with firms that had a lower average level of employees in 1992 were found to have a higher rate of startups in 1999.
  • Cities built closer to coal and iron mines typically build larger, less innovative establishments and are more likely to be less entrepreneurial.
  • Young firms also attract more young workers, who are more likely to take on risks and receive better pay than they would at older firms.

The process of jobs churning in the economy is what Joseph Schumpeter described as creative destruction. The highly complex system occurs at varying rates for a variety of different reasons.

  • Different geographical regions have different supplies of entrepreneurs, which changes over time as the local environment becomes more and less conducive to firm creation.
  • Differing fixed costs, like regulatory hurdles, paperwork and environmental restrictions, can affect whether an entrepreneur starts a firm.

With these economic principles in mind, policymakers can encourage firm creation and job growth by removing barriers to entrepreneurial entry into the market. While the risk involved with entrepreneurship is significant, the firms that succeed typically dislodge older corporations and bring a new wave of innovation. The government should not "pick winners," like it has done in the green industry, but instead let the free market decide which start-ups are best suited to meet the needs of consumers.

Source: Salim Furth, "Who Creates Jobs? Start-up Firms and New Businesses," Heritage Foundation, April 4, 2013.

 

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