December 12, 2011 10:02 pm

US ‘creative destruction’ out of steam

If anybody wants a reason to feel optimistic about America, they might take a stroll through the magnificent trading floor of the Minneapolis Grain Exchange. A hundred years ago, farmers would come here and tip samples of their grain on to heavy wooden desks for merchants to assess. When that business moved on, the floor turned into a place for the open outcry trading of futures and options in hard red spring wheat.

In 2008, that business died too, after the market became fully electronic. But today, the Minneapolis exchange is far from dead; this year, its floor was taken over by CoCo, which lets out space to freelancers and small businesses. Among the ghosts of 19th century farmers, there are new companies catering to mobile advertising, iPad apps, business-to-business online networking, and other niches that the old grain traders never imagined.

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“At home I listen to the news about the economy, and it’s really different from what I see at work,” says Kyle Coolbroth, a CoCo co-founder. “When you come into this space and look at what’s happening, it doesn’t feel like we’re in a terrible recession. A lot of people are rushing into market spaces that haven’t been defined yet.”

During the past three centuries, the American economy has repeatedly remade itself, as pioneers and farmers were succeeded by manufacturing and service industries. This reinvention has been founded on innovation, entrepreneurship and “creative destruction”: the idea that competition removes weak players and sectors from an economy so that new ventures can flourish.

The transformation of the grain exchange brought about by CoCo epitomises that dynamism. Yet, nationwide, there has been a sharp decline in the number of new business launches in the US. That leaves economists pondering a crucial question: is the cycle of creative destruction running out of steam?

The numbers are sobering. From the mid-1980s to the mid-2000s, 450,000-550,000 new businesses with at least one employee were created in the US each year. In 2009, the latest year for which records are available, there were just 400,000. More recent numbers suggest that the climate has not improved: the number of incorporated self-employed people, a measure of the health of small businesses, was 5.06m in November, down from 5.37m in November 2009, official figures say.

A slowdown would be expected in a downturn, but the start of the decline predates the start of the recession at the end of 2007; the peak year for business starts was 2006.

The dwindling birth rate for new businesses matters because young companies are disproportionately responsible for job creation. Indeed, companies less than five years old have generated all of the net jobs in the US economy since the 1970s, according to research published by the Kauffman Foundation.

“Young businesses are the most volatile part of the economy,” says John Haltiwanger of the University of Maryland. “What happens to start-ups is that most of them fail, but among the ones that survive are the fastest-growing businesses in the economy.”

As the rate of new company formation has been slowing, the number of jobs created by each start-up has been falling too – again a trend that began well before the start of the recession. The result is that the total number of jobs created by start-ups, which had been running at 3m-3.5m per year, dropped to just 2.3m in 2009.

The waning force of creative destruction in the US can be seen clearly in employment data. For most of the 1990s, job creation ran at about 8 per cent of employment, with job destruction a little lower at about 7.5 per cent, as the total number of people in work rose. Starting in about 2000, both job creation and destruction began to drift downwards, and carried on falling even as employment recovered after the 2000-01 recession.

As Prof Haltiwanger puts it, the US started to look “more European”, meaning that job turnover, traditionally higher in America, was slowing.

In the 2007-09 recession, job creation plunged while job destruction soared – as would be expected – but the trend since has been less predictable.

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Job destruction has fallen and is now well below its rate in the 1990s, when the economy was much stronger. Job creation, however, also remains very weak, at only about 6.5 per cent of employment. That statistic is the immediate cause of America’s persistently high unemployment.

The question for policymakers, then, is how to fire up the engine of job creation through new business formation and growth. In the near-term, monetary and fiscal policies that sustain demand growth are vital. More orderly politics could also help: there is evidence that uncertainty over economic policy, caused by the dispute in Washington over the US debt ceiling, for example, has a negative impact on small businesses’ expansion plans.

There are some efforts in Washington to get small business going again, however. Senators Jerry Moran, a Republican from Kansas, and Mark Warner, a Democrat from Virginia, have proposed the Start-up Act, drawn up in association with the Kauffman Foundation and Mr Obama’s advisory council on jobs and competitiveness.

Some ideas in the proposal are generally backed by Republicans, including making it easier for companies worth $1bn or less to opt out of Sarbanes-Oxley requirements, and putting a 10-year sunset clause into big new regulations. Others are often supported by Democrats, including immigration reform to make it easier for skilled people to work in the US.

Bob Litan of the Kauffman Foundation says that, individually, each item would be subject to strong political objections, but putting them together in a package labelled “entrepreneurship” might win bipartisan support.

Others say the main problem facing companies is weak demand, not regulation. “We are adjusting to having had an oversupply of everything,” says William Dunkelberg, chief economist at the National Federation of Independent Business.

However, Mr Litan argues that removing barriers to new businesses can only help reinvigorate demand in the economy – “entrepreneurial Keynesianism” is what he calls it.

The belief that some new idea, some improvement or invention is always around the corner is woven into the American fabric. What the official data cannot show is if the spark of the next big idea will emerge from the current malaise.

At CoCo in Minneapolis, though, there is a real sense of optimism. Mr Coolbroth says he already sees signs of a “renaissance” in entrepreneurship, in part because people whose jobs have been cut or who are stuck in uninspiring jobs, as he was, have sought to take control of their own destinies.

Until that renaissance gets under way, the US labour market will not recover properly.

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