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Young Firms Create the Vast Majority of Jobs in an Economy

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Since the National Assembly was established back in 1999, there is has been an increased interest amongst Welsh businesses, politicians and policymakers in entrepreneurship and the development of new businesses.

But why should new firms be supported as statistics show that many do not survive five years? Indeed, isn’t it existing firms that make the biggest contribution to job creation in any economy?

Well, according to research undertaken by the Kauffman Foundation – the world’s leading think-tank on entrepreneurship – that is not the case at all, at least in the American economy.

Its detailed work on the contribution of businesses in the USA has shown that is not the size of business that is important but the age of the firm.

Whilst many believe that all small businesses are the employment engine of the economy, it is actually new and young companies that the primary source of job creation across America. In addition, they contribute significantly to the dynamism of an economy by introducing competition into markets and initiating innovation.

Studies by Kauffman have shown that whilst existing firms, both large and small, are important to the strength of an economy, neither group actually contributes to new job creation as compared to young entrepreneurial businesses.

In fact, in the period between 1988 and 2012, companies more than five years old destroyed more jobs than they created in all but eight of those years.

In contrast, new businesses less than five years old accounted for nearly all net new job creation.

And companies less than one year old had created an average of 1.5 million jobs per year in the USA over the past three decades.

Some would suggest that new firms are too risky as investments, but the study shows that while there is obviously failure, it happens quickly with a pattern of ‘up or out’ amongst start-ups i.e. either they grow rapidly to create jobs and economic growth or they exit the market quickly when they fail. More importantly, many of those entrepreneurs who don’t succeed the first time will try again.

Their significance to the economy is best seen in the context of their performance during the last recession. While older and larger firms shed more jobs than they created, young small firms increased their net employment by 9 per cent.

But incredibly, it would seem that while the USA has also been seen as the land of enterprise, the contribution of new businesses, whilst being higher than older firms, is nevertheless declining. Given their job creating propensity, that is worrying for the US economy.

In fact, the data analysed for the Kauffman report shows that not only are the number of start-ups in the economy declining but those that do exist are creating fewer jobs – the gross number of jobs created by new firms fell by more than two million between 2005 and 2010.

Clearly, given their contribution to employment creation and innovation, this decline could be of concern for the growth of the world’s largest economy if it is not reversed. To deal with this, the Kauffman Foundation suggested that US policymakers should help create an environment more conducive to business formation, such as welcoming more immigrants as they are twice as likely than Americans to start businesses, removing regulatory barriers as they represent a disproportionate cost to start-ups over time, and cultivating human capital as increased entrepreneurial activity is associated with higher levels of education.

Certainly, these are also actions that those in the UK and Welsh Governments may also wish to consider if they are to boost the number of new businesses in the economy.