Why do less and less people start their own business?

There are not many better things (personal things aside) that can happen to a job market candidate than getting mentioned by Tyler Cowen on Marginal Revolution, one of the most widely read economics blogs on the internet. This happened to Nicholas Kozeniauskas from NYU. His paper got judged to be “one of the more important papers of this job market season” by Tyler. And it has indeed many interesting results to offer. Nicholas’ main research question is this:

“Recent research shows that entrepreneurial activity has been declining in the US in recent decades. Given the role of entrepreneurship in theories of growth, job creation and economic mobility this has generated considerable concern. This paper investigates why entrepreneurship has declined.”

Similar declines in entrepreneurial activity have been documented elsewhere. Here, for example, for Germany:

Number of newly created firms per year in Germany. Source: ZEW

Simple explanations have been put forward, such as a demographic change in the population. Traditionally, the inclination to found a new company and become self-employed is highest in the age cohort 35 to 45. And this cohort has become smaller over time due to an ageing population. Nicholas rejects this hypothesis though:

“The decrease in the entrepreneurship rate is therefore a result of changes conditional on age, rather than being due to composition effects.”

An interesting novel empirical observation he makes is that entrepreneurship activity declines overproportionally for people with high levels of education. Between 1994-95 and 2015-16, entrepreneurship rates decreased by 13% in groups with less than highschool education, and by 35% in groups with more than college education (more than a bachelor’s degree). Nicholas discusses three possible explanations in detail:

  1. Skill-biased technical change: Today there is a higher demand for high-skilled labor because our professional environment is becoming increasingly complex. Higher demand increases wages for well-educated people and renders self-employment less attractive for this group.
  2. Increased fixed costs due to regulations: Nicholas refers to increasing barriers to entry due to “occupational licensing, weaker enforcement of anti-trust laws and

    zoning restrictions”, which increase entry costs for new businesses.¹

  3. The superstar firm hypothesis: Technological change has primarily benefitted large incumbent firms. As a result, production becomes increasingly concentrated in a few firms, which start-ups find hard to compete against.

The third mechanism is consistent with what I have documented here and here. Start-ups, especially those which aren’t necessity-driven (e.g., founded out of unemployment), are seen as a driver of innovation and creative destruction. But it seems that, although overall R&D investment is increasing, fewer (but larger) firms are actively engaged in innovation activities. If these days it’s harder for start-ups to come up with an innovative business model and disrupt an industry, entrepreneurship will be less attractive, in particular for high-skilled founders. At the same time, it becomes more difficult to develop completely new markets by using novel technologies and offering products that nobody has offered before.

Based on a general equilibrium model, calibrated to the data, Nicholas comes to the following conclusion:

“I find that an increase in fixed costs explains most of the decline in the aggregate entrepreneurship rate and that skill-biased technical change can fully account for the larger decrease in entrepreneurship for more educated people when combined with the other forces.”

Increasing productivity in non-entrepreneur firms—the superstar firm hypothesis—affects entrepreneurship primarily at the intensive margin, leading to smaller but not necessarily fewer start-ups. Still, about 15% of the overall decline in entrepreneurship between 1988 and 2016 can be explained by this channel.

¹ It’s a little unfortunate that he equates fixed with entry costs here, in my view.

2 thoughts on “Why do less and less people start their own business?”

  1. This is really a minor point but — do you think being highlighted on MR really does give a large boost to candidates on the job market?


    1. It’s as much of social media impact you can get in economics, apart from being cited by Krugman perhaps. I can’t tell whether it helps you to get more interviews but my feeling says yes. Would be an interesting research question though.


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