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Explaining Trends in New Business Creation

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What do new data on business creation mean for economic recovery—and for policymakers seeking to support that recovery? On one hand, entrepreneurship appears to be surging. On the other hand, part of that surge might be entrepreneurial activity that doesn’t necessarily lead to job creation. Here, we look at three different datasets and what they might be telling us about entrepreneurship, jobs, and the economy.

Business Applications Surging

During the first quarter of 2021, on average, 450,000 new business applications were filed with the government. That was nearly double the pre-COVID monthly average. Since July 2020, the monthly average for new business applications has been 90 percent higher than the pre-pandemic average from 2004 to February 2020. This is according to data collected by the Census Bureau in its Business Formation Statistics.

What is a “new business application”? It’s a filing with the Internal Revenue Service for an employer identification number, EIN. As the nearby chart shows, monthly business applications generally trended upward from 2014 to the beginning of 2020. They shrank sharply in the early stages of the COVID-19 pandemic in March and April 2020. Record-setting months followed.

Not all business applications are classified the same way, however. Some are deemed to be “high-propensity,” meaning the Census Bureau deems them to have a high propensity of becoming an employer business. That is, one with employees. Thus, some applications are from “likely employers” and some are from “likely nonemployers.” This determination is based on a set of factors.

As shown in the chart, the monthly number of high-propensity business applications never recovered from the Great Recession. The monthly average, from mid-2009 to February 2020, remained about 23 percent below the 2004-07 average. Since then, from July 2020 to March 2021, the monthly average of high-propensity applications has been 32 percent higher than the pre-pandemic average.

Business applications, from both likely employers and likely nonemployers, has surged since the summer of 2020. Analysis by John Haltiwanger has shown that this surge has been particularly strong for restaurants and retail stores, especially e-commerce. Given the nature of the crisis of the past year, that’s not too surprising.

More New Businesses, Less Opportunity?

The overall increase in business creation in 2020 is also reflected in another set of data from the Census Bureau, the Current Population Survey. This is one input into the Kauffman Foundation’s annual report on early-stage entrepreneurship. The report for 2020 shows a record high “rate of new entrepreneurs,” at 0.38 percent. This indicates that, in any given month, 380 out of every 100,000 Americans were involved in starting a new business—that they were not doing three months earlier.

As the chart indicates, this was a sharp increase over 2019—after two years of decline—and the highest level in 25 years of data. Encouragingly, the rate of new entrepreneurs increased for every demographic group: men and women, immigrants and the native-born, every age group, every educational level, and every race and ethnicity.

The Kauffman Indicators and CPS data also track what’s called the “opportunity share” of new entrepreneurs—the percentage of new entrepreneurs who are starting a business in pursuit of a new opportunity. This is held to be the opposite of so-called “necessity entrepreneurs,” who start a company when they’re unable to find a wage or salary job. In 2020, the opportunity share of new entrepreneurs was 70 percent, the lowest level recorded in the dataset.

With millions of Americans entering unemployment in 2020, many turned to self-employment to try to make ends meet. This finding accords with another insight from the BFS data: there were twice as many business applications from likely nonemployers in the first part of 2021 than from likely employers.

Temporary or Trend?

Prior to the COVID-19 pandemic, the rate of new (employer) business creation in the United States had fallen steadily for four decades. This is different from the business application data above, and comes from yet another Census Bureau dataset, Business Dynamics Statistics. The BDS tracks, among other things, “firm formation” of employer businesses. It effectively captures the transition of those high-propensity business applications from an EIN filing form to an actual business with payroll.

Prior to the pandemic—or, at least, through 2018, the latest year for which data are available—new employer business creation was on a long-term downward trend.

After a historically large drop in 2008 and 2009, business creation recovered only slowly—and did not reach pre-recession levels. From 2010 to 2018, annual new business creation was about 14 percent lower than from 1978 to 2007.

To some observers, the surge in business applications represents a reversal of this trend. To others, the 2020-21 surge is a blip, a function of the pandemic. Reality could be a bit of both. There is a school of thought about downturns being good times to start a new business: competition might be weak, inputs (labor, supplies) might be cheap. Historically, the rate of new entrepreneurs (what’s tracked in the Kauffman-CPS indicator) does tend to rise with unemployment.

The surge could also reflect the dynamics of the pandemic. Many of those who would have filed new business applications in April 2020 may have delayed it until August, in effect shifting what is seen in the data. We know, too, that tens of thousands of small businesses had to permanently close their doors in the spring of 2020. Many business owners may have embarked on completely fresh starts later in the year, with new ideas and new businesses.

Whatever the reasons for the surge or what it might represent, policymakers can take action to ensure that it helps drive recovery. Strong rates of business creation—especially among likely employer firms—will contribute to strong rates of job creation. The good news is there is bipartisan support for policy actions that will help new, existing, and aspiring business owners. What’s needed is intense work to determine what policy actions will actually be meaningful to entrepreneurs and supportive of business owners. Stay tuned for more from the Bipartisan Policy Center as we engage in that work.

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