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News : Innovation Last Updated: Aug 30, 2010 - 6:09:10 AM

Net job growth in US driven entirely by startups
By Michael Hennigan, Founder and Editor of Finfacts
Aug 27, 2010 - 8:41:32 AM

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When it comes to US job growth, startup companies aren’t everything. They’re the only thing according to research published last month.

A study by the Kauffman Foundation, which focuses on entrepreneurship, says new firms add an average of 3 million jobs in their first year, while older companies lose 1 million jobs annually  -- both on average and for all but seven years between 1977 and 2005, existing firms are net job destroyers, losing 1 million jobs net combined per year. By contrast, in their first year, new firms add an average of 3 million jobs. Further, the study shows, job growth patterns at both startups and existing firms are pro-cyclical, although existing firms have much more cyclical variance. Most notably, during recessionary years, job creation at startups remains stable, while net job losses at existing firms are highly sensitive to the business cycle.

The study, The Importance of Startups in Job Creation and Job Destruction, bases its findings on the Business Dynamics Statistics, a US government dataset compiled by the US Census Bureau. The BDS series tracks the annual number of new businesses (startups and new locations) from 1977 to 2005, and defines startups as firms younger than one year old.

Last week, in a paper, which reports on research using the same dataset, the researchers say an enduring notion about the US economy is that small businesses create most private sector jobs. They stress it's young firms rather than small firms which are responsible for most new net jobs.

John C. Haltiwanger, Ron S. Jarmin and Javier Miranda, say firm startups account for only 3% of employment but almost 20% of gross job creation. Young and small businesses disproportionately create and destroy jobs and large mature firms exhibit robust adjustments along the establishment entry and exit margins.

However, they also show that large, mature businesses account for a large fraction of jobs. Firms over 10 years old and which have more than 500 workers, account for about 45% of all jobs in the US private sector. In turn, they show that these large, mature firms account for almost 40% of job creation and destruction.

The researchers say young firms exhibit high rates of gross job creation and destruction. Consistent with this pattern, they find that young firms have very high job destruction rates from exit so that after five years about 40% of the jobs initially created by startups have been eliminated by exit. However, they also find that, conditional on survival, young firms grow more rapidly than their more mature counterparts. In combination, their findings suggest a rich “up or out” dynamic of startups and young firms that is consistent with models of market selection and learning. The researchers say understanding the process of job creation by private sector businesses requires understanding this dynamic. Policies that favour various simply defined classes of businesses (e.g., by size) and ignore this fundamental dynamic will likely have limited success.

Another Kauffman Foundation study published this month, says conventional thinking on employment from startups is that many of the jobs they create evaporate as a high percentage of them fail only a few years later. The new study, After Inception: How Enduring is Job Creation by Startups? found, instead, that, while many new firms fail, destroying jobs, others also thrive and create jobs. This growth in employment partially balances out the jobs lost by closing and shrinking firms.

The study says the jobs created when startups are established do not disappear overnight. In fact, they are remarkably durable. When a given group of startups reaches age five, the group's employment level is 80% of what it was when it began. In 2000, for example, startups created 3,099,639 jobs. By 2005, the surviving firms (half of those that had started) had total employment of 2,412,410, or about 78% of the jobs that existed when these firms were born.

The study bases its findings on an analysis of the Business Dynamics Statistics (BDS) dataset broken out by firm age to determine how total employment in startups changes as those companies age.

By 25 years after firms start, only about 20% of them still exist, but the employment numbers appear to level off at around 68% of their initial values. The fact that establishments have decreased so rapidly yet employment has more or less leveled out means surviving firms continue to grow. Firms fail, but growth, even at these well-established firms, continues, keeping employment from dropping with the number of establishments.

"Even starting a company during a recession adversely affects the new firm for only a limited time," said Robert E. Litan, vice president of Research and Policy at the Kauffman Foundation. "While a recession has a negative effect on a company’s employment in its first few years, a recession does not impose lasting consequences on startups. By age five, these firms’ employment reaches roughly the same level as firms that were not started in recessions. So, firms started during the current recession can expect their employment to catch up with longer-term companies in the years to come."

Exposure to prolonged or repeated recessions, however, does adversely affect job creation. Firms that weather many recession years seem to consistently have lower levels of employment, the study showed, with startups surviving through three recession years having about 10% less employment than those surviving through none. This amounts to a difference of about 300,000 jobs, or around 0.2% of all jobs in the economy. While the number of jobs lost due to prolonged or repeated recessions appears to be small, these small differences might compound over the years and across groups of companies to create a lasting mark on the economy.

The study says the current recession is the longest in several years; thus, startups established right before or at the beginning of the current recession might have been significantly affected. On the other hand, as the US economy climbs its way out of recession, the cohorts of new firms started now likely will not be affected similarly, because they will have survived through fewer recession years.

The Importance of Startups in Job Creation and Job Destruction (pdf)

Who Creates Jobs? Small vs. Large vs. Young  -- John C. Haltiwanger, Ron S. Jarmin and Javier Miranda

After Inception: How Enduring is Job Creation by Startups? (pdf)

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