Entrepreneurship May Work Like A Clock, But It Still Needs Winding: Exploring the Kauffman Study on New Firm Formation

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the same level of consistency in firm formation over time. And even if the incorporation records were undercounting some firms, and thus perhaps missing some level of fluctuation within the uncounted ones, it wouldn’t explain the clockwork consistency in the number of new firms that were counted.

The two researchers also considered the possibility that the period for which they had the best data, 1977 to 2005, was anomalous in some way, and that other eras of U.S. history might show more tumult. But when they examined Census Bureau data covering the period 1944 to 1959, they found that even though the sheer number of jobs created then was lower because of the smaller population, there was still the same eerie consistency.

The single exception was 1946, when more than 600,000 new firms were founded, compared to the base level for the period of 400,000 per year.  (Annual firm formation grew between 1960 and 1977 to the 700,000 level and has stayed steady since then.) In fact, 1946—when so many veterans were returning from overseas, and the wartime economy was being converted back to consumer production—was the only year, out of all the periods Kedrosky and Stangler examined, where they thought they could detect the influence of an “exogeneous factor” on the steady drone of new company formation.

So the phenomenon seems real. But what could possibly explain it? In their paper, Kedrosky and Stangler run through about half a dozen hypotheses; I won’t detail most of them here. In the end, Stangler tells me, only two of the explanations seemed compelling to him.

One is demographic stability. Between 1950 and 1975, the share of the overall U.S. population that was of working age, meaning between the ages of 15 and 64, fluctuated quite a bit. But around 1977, this number settled down, and stayed steady (at about 66 percent) throughout the entire 30-year period the Kauffman researchers examined. If a country has a stable population of relatively young, working-age people, then you might expect the number of new businesses they start every year to be roughly constant. (If there’s any truth to this hypothesis, Stangler points out, then we may be in for some big changes on the entrepreneurial scene, since the approaching retirement of the Baby Boom generation means the non-working population is about to get a lot larger.)

The other explanation that Stangler likes has to do with how we define startups. For most Xconomy readers, the word “startup” probably brings to mind a young company innovating in some area like information technology, energy, or biotechnology. And the rate of formation of those types of startups may indeed be sensitive to factors like whether we’re in the midst of a technological revolution (e.g., the PC or mobile revolutions) or how flush venture capitalists and their limited partner investors are feeling. But in fact, the vast majority of new companies formed every year may be much more prosaic: restaurants, law offices, retail stores, bookkeepers, medical clinics. The demand for such service-oriented businesses may be more or less consistent, tracking only with population levels—which might, one could imagine, induce a consistent number of entrepreneurs each year to act to meet the demand.

“If you just read the glossy magazines, you’d think that all startups are software companies, and if you just read the economics research, you’d think that all startups are in manufacturing, because that’s the sector with the best data,” says Stangler. “But there is this huge gap between those two things and the reality, which is that there are a lot of quote-unquote ‘normal’ companies where people are taking a chance and pursuing an opportunity. The research has not seen them as real entrepreneurs, but they are still going to create jobs.”

If this theory is right, you wouldn’t think that it would be very difficult to test it. But in fact, Stangler says the data on what kinds of companies get created every year is very fuzzy. The Census Bureau breaks companies down into nine huge “super-sectors,” with everything from healthcare to education to R&D getting lumped into one big sector called “Services.” So Stangler says he and Kedrosky will need to do more research to disentangle technology-driven startups from others, and to figure out whether exogenous factors have more impact on entrepreneurship in some sectors than in others.

There’s a big caveat to all of this: The detailed firm formation data that Stangler and Kedrosky located only covers the period 1977-2005, meaning we don’t know yet what effect the Great Recession of 2007-2009 had, or may still be having, on levels of entrepreneurship. “This may be an inflection point where we are going to see … Next Page »

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Wade Roush is a contributing editor at Xconomy. Follow @wroush

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