from the Kansas Fed
— this post authored by Justin Barnette and Andrew Glover
The rate of new business formation has declined sharply in recent decades. From 1989 to 2017, the share of new businesses in total businesses fell by one-third, while new businesses’ share of total employment fell from 1.5 percent to 1.0 percent. These declines have raised concerns among economists about job and productivity growth. The majority of new businesses are small businesses, which accounted for 65 percent of net job growth in the United States in 2019. In addition, new businesses are a major contributor to aggregate productivity growth, adding 0.15 percentage points annually, whereas firms older than 10 years contribute almost 0 percent on net (Alon and others 2018).
The observed decline in new businesses can be juxtaposed to an increase in household wealth (the net worth of real and financial assets less liabilities) that in theory should affect households’ propensity to become entrepreneurs. Economic theories of business formation suggest that wealthier households are more likely to start a business because wealth allows them to more easily reach a profitable scale. Previous researchers have verified this effect in household data, especially for the very wealthy (Quadrini 2000; Hurst and Lusardi 2004). As a result, we would expect business formation to move in the same direction as household wealth.
In this article, we use data from the Panel Study of Income Dynamics from 1989 to 2015 to estimate the effect of wealth on the probability of a household starting a business while taking other observable characteristics into account. We find a puzzling divergence: business formation declined over the past three decades even as household wealth increased. However, we find that higher wealth is associated with an increase in the probability of starting a business during any given year, consistent with economic theory. In other words, we do not find evidence that the relationship between business formation and household wealth has changed in the cross section. Instead, some other factor likely explains why business formation rates fell as households became wealthier.
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Source
https://www.kansascityfed.org/documents/8109/er2q21barnetteglover.pdf
