US economy: Decline of the start-up nation

Posted on August 4, 2016

Attendees watch a talk during the TechCrunch Disrupt NYC 2015 conference in New York, U.S., on Tuesday, May 5, 2015. TechCrunch features leaders from various technology fields and includes a competition for the best new startup company. Photographer: Michael Nagle/Bloomberg©Bloomberg

A TechCrunch summit in New York, which hosted a contest for best start-up

In the desert city of Tucson, Arizona, local entrepreneurs have gathered in the Pueblo Vida bar for a crash course in failure.

The standing-room-only evening in the sweltering downtown area is called F*ckUp Night. Business owners freely recount their own mishaps, including one whose attempt to make money turning restaurant grease into biodiesel fuel never got off the ground.

    Readiness to fail is essential to entrepreneurship and more aspiring businesspeople need to recognise it, shouts Felipe Garcia, who imported the format from Mexico City, over the noise of the crowded bar. “They are afraid of failing,” he says. “No one wants to say ‘Hey, I messed up.’”

    Glugging beer brewed on site, the entrepreneurs share ideas about products ranging from eco-friendly dinner plates and unmanned aerial vehicles to technology that cools car seats.

    Yet the bustling entrepreneurialism evident in this corner of Tucson, a cactus-strewn metropolitan area 60 miles from the Mexican border, has become harder to find in many parts of the US.

    While major cities including San Francisco, Boston and New York are flourishing, a host of indicators suggest large tracts of America have lost some of the entrepreneurial verve that made the country the biggest economic success story of the past century.

    Half of the growth in business establishments from 2010-14 occurred in just 20 counties, according to the Economic Innovation Group, a research organisation. Pima County, where Tucson is located, was among those that lost businesses during the period.

    The patchy performance in business formation comes amid broader signs that the US is not the start-up nation it once was. Despite headline-grabbing tales of tech unicorns in Silicon Valley, the portion of the US workforce employed in young companies has been shrinking, as has the pace at which new employer-owned businesses are created. In another sign of depressed dynamism, Americans change jobs and move between geographies less frequently.

    US startups charts

    Figures released yesterday by the Kauffman Foundation, which tracks entrepreneurship in the US, showed that the share of companies that are start-ups employing at least one person was at the second-lowest level on record in 2013, and 20 per cent below its pre-recession levels. There has been improvement since, with a bounce in openings in the fourth quarter of 2015 to their highest level in 10 years.

    But the improvement has not been enough to dispel the musty air surrounding large parts of American business. Companies are growing older, competition is less fierce and market power is consolidating in the hands of a few large companies in many industries.

    In three-quarters of US sectors, the 50 biggest companies boosted their revenue share between 1997 and 2007, according to research by Jason Furman, chairman of President Barack Obama’s Council of Economic Advisers, and Peter Orszag, an economist and banker. Industries from retail and finance to transportation became increasingly concentrated.

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    “Without question there is less fluidity in the US economy, whether it comes to workers moving between jobs or firms entering and exiting,” says Mr Furman. Weaker business formation “is an important focus of attention and something we need to take seriously. Unfortunately academics and experts don’t fully understand what is happening.”

    The suggestion that the US has a problem in the entrepreneurship department has come as a jolt for a country that prides itself in the red-blooded capitalist spirit that spawned the likes of Henry Ford, Ray Kroc and Steve Jobs.

    That exceptionalism was at the heart of Hillary Clinton’s attempt to paint an optimistic picture of a dynamic America in her acceptance speech at the Democratic party’s convention last week.

    Drawing a contrast with the bleak image of American decline painted by her opponent Donald Trump a week earlier, the former secretary of state lauded the country’s entrepreneurs as the world’s most innovative. “We have the most dynamic and diverse people in the world,” she told the convention.

    Stifled competition?

    By many measures Mrs Clinton is right. Indexes that show the ease of doing business and global entrepreneurship put the US at or near the top of the rankings. In world-beating, technology-rich areas such as San Francisco and Silicon Valley, business is booming and effervescent activity can be found in plenty of other niches.

    US startups map

    Andrew Geffken, an energy consultant turned entrepreneur, points to his sector, craft brewing, as evidence of frenzied growth with new breweries and distilleries popping up across the country. He quit a steady job to help start a Baltimore-based fermenter of mead targeted at millennials called Charm City Meadworks that is on track to double its revenue this year to $850,000. “It is a good time to be an entrepreneur, at least in my segment,” he says.

    While there has been a long-term decline nationwide in the share of businesses that are start-ups, analysis from the OECD finds similar trends in its other member countries, suggesting the US is by no means uniquely challenged.

    Nevertheless, concern about subdued capitalist mojo and ageing businesses is circulating at the highest level of policymaking, triggering congressional hearings and worried commentary from the Federal Reserve and International Monetary Fund.

    US startups charts

    The stakes are particularly high because of America’s miserable productivity performance in recent years, as well as the poor income growth and rising inequality that has hung over the presidential race. Newer companies tend to be more innovative than established ones, and the IMF warned in a recent report that the lack of start-ups is eating into US productivity.

    At the same time, the power of established companies may be stifling some of the opportunities for new entrants, while workers at companies generating outsized earnings may be reluctant to jump ship to new companies. In an acknowledgment of the concentration problem, President Obama in April issued an executive order telling government agencies to take steps to promote competition in the country.

    “Most of the net new jobs in the US are created by young businesses, and new firms are responsible for a lot of the innovation and wealth creation in the economy,” said Arnobio Morelix, a senior analyst at the Kauffman Foundation. “It is worrying that we are seeing a long-term decline in new business formation.”

    Former coal miner Jim Ratliff stands for a photograph at the Bit Source LLC office in Pikeville, Kentucky, U.S., on Monday, Feb. 1, 2016. Bit Source is a tech startup firm thats out to prove theres life after coal for the thousands of industry veterans whove lost their jobs in an unprecedented rout that has already forced five major producers into bankruptcy. Bit Source has only hired 10 coders, but almost 1,000 responded to its ads as the realization spreads across Appalachia that coals heyday is over. Photographer: Sam Owens/Bloomberg *** Local Caption *** Jim Ratliff

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    The question is why this is happening — and it is here that consensus quickly breaks down. Some analysts have suggested there is a particular problem with millennials, who perhaps as a result of record-high levels of student debt or a paucity of home equity with which to leverage loans, are starting businesses at a lower rate.

    But the problem with blaming it on a particular generation is that the trend of declining start-up activity has been under way since the 1970s. Indeed, the most recent two years of Kauffman data have shown a pickup in entrepreneurial activity among 20-34 year olds, even if the share of new entrepreneurs in that age group is below levels in the 1990s.

    Other research focuses on burdensome regulation and problems with access to capital as key barriers to a bigger resurgence in business growth.

    A quarter of workers require a licence to do their jobs, with the share of workers licensed at a state level up fivefold since the 1950s. This explosion of paperwork, which affects professions ranging from manicurists to interior designers, is dragging on job switching, state-to-state mobility and employment opportunities, prompting calls for reform by the White House and some lawmakers.

    What’s more, small companies do not have the resources that big incumbent companies enjoy when it comes to navigating America’s thicket of local, state and federal regulations, which may be making it harder for start-ups. Steve Glickman of the EIG points out that new companies also lack the lobbying budgets and power to affect regulation.

    A paucity of capital, driven in part by tougher post-crisis lending standards and financial regulation, is making matters worse, says Patrick McHenry, the Republican vice-chairman of the House Financial Services Committee and a North Carolina congressman. In July he won bipartisan support for two bills aiming to smooth access to capital for smaller companies. The bills will now go to the Senate. “We have capital deserts in this country in places where there are plenty of new ideas,” he says, pointing out that nearly four-fifths of venture capital goes to just three states: New York, Massachusetts and California. “What we have got to do is spread those economic opportunities more broadly across the 50 states.”

    US startups charts

    Complaints about the difficulty of accessing venture capital are heard frequently in Tucson, which like large tracts of America are off the beaten track for the big players. Manny Teran, president of a Tucson technology-development company called Aztera whose products include a machine that turns hospital patients over in bed, says access to capital is a problem in his region. “They are flying right over,” he says of VC bosses. “They are not stopping here.”

    ‘Jump off the cliff’

    Pima County, where Tucson is located, saw a 1.9 per cent decline in the number of new business establishments from 2010-14, according to data compiled by EIG. That differs from the rebounds following the 1990s and 2000 recessions, when it saw business establishment growth of more than 10 per cent.

    By contrast, Maricopa County, home to the much larger Phoenix, only an hour and a half’s drive north of Tuscon, saw 3.5 per cent establishment growth during the current recovery.

    Some entrepreneurs argue that Tucson lacks the critical mass to provide the base for large numbers of entrepreneurs. Vivek Kopparthi, the Phoenix-based chief executive of NeoLight, a young company making equipment for treating jaundice in infants, says start-up founders like him want to be in big, highly connected cities such as the Arizona capital. “This [Phoenix] is where everything is happening. People come from Tucson to Phoenix, not from Phoenix to Tucson,” he says.

    Yet Tucson’s advocates say it has the raw materials to become a bigger business hub. P
    rogrammes run by Startup Tucson, which seeks to bolster local enterprise, are heavily oversubscribed, with 40 companies applying for one incubator course with 18 places.

    Among the attendees at a recent session was Brian Herrera, a 23-year-old former University of Arizona student, who stood up to practise making a pitch for his virtual reality company, Vidi VR.

    More of Mr Herrera’s contemporaries will need to join him in coming years — and accept the risk of failure — if the start-up deficit is to be turned around.

    “A lot of people get really comfortable and are not willing to take a risk,” says Mr Herrera, who first started working on his company’s 3D camera in his bedroom. “You have to jump off the cliff and figure out how to grow wings before you hit the ground.”

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    Universities need to focus less on “cranking out managers” and devote more effort to fostering entrepreneurship says Michael Crow, president of Arizona State University. The institution has been prodding its students into starting their own companies by integrating entrepreneurship into its curriculum.

    The need seems clear. Around a quarter of new entrepreneurs are aged 20-34, according to the Kauffman Foundation, down from 34 per cent in the mid-1990s. That slower start-up activity comes despite an explosion in the number of entrepreneurship classes and diplomas on offer at colleges and universities, with courses growing approximately 20-fold between 1985 and 2008.

    In a bid to boost business start-ups, a growing number of universities are taking things into their own hands — providing funding to promising students, on top of academic instruction. ASU, for instance, has an initiative to provide seed funding of up to $20,000, plus office space and mentoring.

    The competition for funds is intense says Patrick McFarland, an engineering student and head of Korwave, which is developing a wearable piece of kit that detects and reports medical seizures.

    On a bigger scale, the University of California recently started a $250m venture capital fund to invest in companies with ties to its institutions and laboratories. The University of North Carolina at Chapel Hill has started a fund to channel up to $10m into companies commercialising technology developed at the university.

    Chris Camacho, chief executive of the Greater Phoenix Economic Council, says his city’s experience shows how much the presence of a strong university can mean for a region’s entrepreneurial growth. “I see a growing divide between those markets and everyone else,” he says.

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