America’s start-up scene is looking anemic

Font Size

By Noah Smith

WHY AREN’T PEOPLE starting more start-ups? That might seem like a weird question to ask, in an age when Silicon Valley ventures are hot commodities and money and talent is flooding into machine learning companies. But in fact, Americans don’t start businesses like they used to.

Some of this decline has come from the decline of small businesses. When national chains like Walmart Inc. and Target Corp. can come to town and muscle out the competition, there’s not much point in opening a mom-and-pop shop. Online retailers like Inc. just compound the effect. Research indicates that this has been responsible for much of the overall decline in entrepreneurship.

That’s worrisome, because small business was traditionally one of the main gateways to the middle class. Without the option of starting a corner store, Americans without high skills or advanced degrees will find it that much harder to maintain comfortable lifestyles. Instead, many will have to seek jobs from large corporations, depriving them of personal autonomy and possibly driving down wages due to the increased competition for jobs.

This is an old and well-known problem. The decline in business formation in the retail and service sectors has been happening since the 1980s, even though the US government has enacted a steady stream of policies to counteract the trend. More initiatives to put the government’s thumb on the scale in favor of small businesses would probably be a good thing, but the decline in new retail businesses isn’t an acute crisis.

More worrying, however, is the decline in high-tech business formation. Tech businesses, unlike corner stores, tend to be high-growth businesses that employ lots of people. That same demand for labor also probably helps to drive up wages. And perhaps most important for the long term, technology startups are important for productivity growth.

Innovation is at the core of what tech startups do. They don’t necessarily do original science, but they take scientific findings and new technologies and combine them with creative new business models. That results in either better or cheaper versions of existing goods — for example, improved lithium-ion batteries — or entirely new goods that people didn’t even realize they would want, like coding tool GitHub (which was recently acquired by Microsoft Corp. for $7.5 billion). Newer, better and cheaper products raise the overall standard of living in the economy.

So it’s disturbing to see that high-technology start-ups have also been getting rarer. Here is a graph from a recent paper by economists Ryan Decker, John Haltiwanger, Ron Jarmin and Javier Miranda, who study economic dynamism and business formation, showing the percent of young businesses in various sectors:

The data only goes through 2013, so it’s possible that the last few years have seen a reversal of the trend. The Great Recession — from which the recovery only really began in earnest in 2013 — probably pushed these lines downward. But there are reasons to think there hasn’t been much of a start-up recovery. Chris Canipe of the website Axios notes that startup formation has barely ticked up in the last few years. While it’s possible that high-tech companies are bucking the overall trend, it seems unlikely.

So why are so few high-technology companies being formed in the US? There are a number of possible explanations. The boom in high-tech activity in the 1990s might have been a one-time bubble, or a temporary burst of activity in response to the invention and expansion of the internet. Davis et al. also mention the possibility that the US’s aging population might result in fewer founders and high-tech workers. An extremely pessimistic possibility is that there might simply be fewer new technologies and ideas to exploit.

But it’s also possible that the high-tech sector is becoming dominated by a few big players, leaving less room for innovators to break in. Tech titans like Amazon, Facebook Inc., Apple Inc., Alphabet (Google) and Microsoft have grown to staggering size.

These companies may be such powerhouses that entrepreneurs don’t find it worth their while to enter the market, because they’ll just get out-competed.

If Alphabet et al. are actually doing their own innovation, like Bell Labs or Xerox PARC in past decades, then this isn’t that big of a problem. But if it’s merely the threat of big-company competition keeping tech entrepreneurs out of the market, the picture looks worse.

Suppose I have a great idea for a new kind of algorithm to match customers with products. I could start my own online retailer built around that algorithm, but Amazon could just copy it (rather than acquiring my company), so I don’t. Yet in this hypothetical example, since I don’t actually start my start-up, Amazon actually doesn’t invent the new recommendation algorithm, and the innovation never gets done!

In other words, big tech companies might be acting like Walmart and Target, but muscling out tech startups rather than mom-and-pop stores. But unlike the retail sector, competition in the innovation space might sometimes leave new ideas unexploited.

The source of the decline in startup dynamism isn’t yet known. More research, and better understanding of the last few years, is needed before any definitive conclusions are reached. But if the tech sector is getting too concentrated, regulators might take a second look at options to reduce the dominance of the big players. — Bloomberg

This article does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.