Many Americans today—especially those who work in financial markets—see their economy as pushing at the bleeding edge of entrepreneurship, innovation, and competition. But this picture is not accurate. In reality, there is a large and growing body of evidence that U.S. business dynamism is in trouble—and may indeed be experiencing an accelerating decline. Possible reasons range from demographic aging and generational change to network effects and regulatory capture. This note serves as an introduction to our visual guide through the evidence and the issues.
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“Declining business dynamism” is a hot topic today among economists and policymakers. But what exactly does this phrase encompass? Let’s define “business dynamism” as the process of Smithian or Schumpeterian creative destruction by which jobs, firms, and ideas are reshuffled to their most productive uses. By that measure, most Americans probably think their economy is doing pretty well. To wit, they are likely to believe the following:
- Spurred by huge technological gains and an ongoing economic recovery, productivity growth is surging.
- Jobs and firms are being created and destroyed at an unprecedented rate to meet the new needs of our innovation-driven economy.
- More Americans are being matched with better jobs thanks to mobile IT and online networking, leading to higher rates of job churn and geographic mobility.
- Creative disruption has turned the market into a revolving door. The average U.S. firm has gotten younger and leaner.
- The rise of billion-dollar IPOs is evidence of higher turnover at the very top of the market.
- Most industries are becoming more competitive due to the speedier transmission of “best practices” to rival firms.
- Pricing power is waning in an economy in which more firms are pressing up against the productivity frontier.
It makes for a compelling story. But all of it is untrue. In fact, most of the data we have on business dynamism seem to be pointing in the opposite direction.
The emerging literature on declining business dynamism traces back to 2014 and 2015, when experts began noticing that the economy wasn’t bouncing back as strongly as expected. Upon further digging, they uncovered a wide variety of “symptoms” pointing to an extended decline in business dynamism that predates the financial crisis—symptoms including everything from a decline in new firm formations to a rise in monopoly power. In this report, we divide these symptoms into nine categories:
- declining rates of job creation and destruction
- declining rates of job churn and geographic mobility
- declining rates of company start-ups and firm turnover
- declining number of total firms and (especially) listed firms
- growing age and size of typical firm
- declining turnover/turbulence in S&P 100 giants
- weakening firm response to productivity gaps
- rising market concentration
- a widening divide between winners and losers
Taken together, these symptoms are evidence of a disease that may threaten America’s long-term economic future. Business dynamism is inextricably linked to labor productivity growth: Higher dynamism enables more efficient reallocation of economic resources to the most productive firms, which boosts aggregate productivity growth. Lower dynamism, by contrast, constrains productivity growth—and by extension, GDP growth.
There are a wide range of factors that could be contributing to declining business dynamism. Some are rooted in demographics, like workforce aging and generational change. Some are triggered by globalism and the new IT revolution, like network effects and infinite returns to scale. Still others are linked to America’s political economy, like regulatory capture and new antitrust policies that favor incumbent giants. The list includes:
- demographic aging
- generational change
- rise of IT & global markets
- dysfunctional IP/patent system
- regulatory capture
- ebbing antitrust enforcement
- productivity exhaustion
- policy sclerosis & civic distrust
Identifying this disease is one thing—but treating it is quite another. Because of the disparate factors at play, there are a wide range of policy fixes that might plausibly help resuscitate business dynamism. The political right tends to favor policies that strip away regulations and limit governmental overreach. The left tends to favor policies that break up big companies, enhance the bargaining power of labor, and redistribute income. Increasingly, leaders on both sides are coming to an agreement on middle-ground policies, including stricter “economic” antitrust policy, reform of patent/IP law, and deregulation of professions.
To be sure, none of the aforementioned policies promise a complete fix. We still have much to learn about declining business dynamism—but if one thing is clear, it’s that an all-encompassing solution will require plenty of coordination between economists, academics, and political leaders. The future of our economy may very well depend on it.
TAKEAWAYS
Americans often view their economy as increasingly fast-paced, competitive, and entrepreneurial, full of disruption and accelerating turnover. But this picture is inaccurate: The data show that so-called “business dynamism” has been declining for decades.
- The common conception of America as an entrepreneurial powerhouse is misleading. Popular works of literature praise America as a land of innovation and opportunity. As the story goes, today’s billion-dollar upstarts are changing the way we work and live. Technology is ushering in an age of unprecedented economic and social progress. In every annual letter to shareholders, Warren Buffett continues to extoll this country’s “economic dynamism,” which (he says) is looking “better than ever.” No need to worry about the untamable energy and swagger of 21st-century market capitalism. But these breathless assurances ignore the abundance of data showing that dynamism is on the decline—however you measure it.
- In the near term, global superstar firms are a good bet. Size, scale, and future pricing power beat value picks in today’s market. Companies with higher productivity, higher margins, higher ROA, and stronger business moats than their competitors are the clear winners. Proof? One recent study followed a long-short portfolio favoring listed firms in industries experiencing the most rapid concentration gains. In the decades before 2001, this portfolio generated negligible alpha. But in the years since 2001, it beat the market by an impressive 7.2% annually. On a range of measures (total return on assets, profit margin, patent generation), the best recent gainers have been firms that enjoy pricing power.
- But longer term, these firms are no lock. At some point in the future, the tide may shift abruptly. This shift could be kicked off by any one of three factors (or some combination thereof): a falling market and economic slowdown; geopolitical shock; or a populist/authoritarian backlash. History shows that eras of corporate “bigness” don’t last forever. Sometimes it takes a downturn or a geopolitical scare for markets to recalibrate (the Great Recession, for instance). Other times, policymakers respond to public backlash by retilting the playing board (the breakup of the Bell System). Either way, there will come a time when size and incumbency are seen as flaws, not features.
