Where Will the Jobs Come From?

Compared to all prior recessions since the end of World War II, the 2007-2009 recession ranks worst in terms of the number of jobs lost (over eight million), and second worst in the percentage decline (6 percent). The key to economic recovery will come in the form of newly created jobs. But where will these jobs come from?

Using United States Census Bureau data from 2006-2007, this paper examines net new job creation in terms of firm age rather than firm size. Until 2005, we knew that from 1980-2005, nearly all net job creation in the United States occurred in firms less than five years old. This data set also shows that without startups, net job creation for the American economy would be negative in all but a handful of years. If one excludes startups, an analysis of the 2007 Census data shows that young firms (defined as one to five years old) still account for roughly two-thirds of job creation, averaging nearly four new jobs per firm per year. Of the overall 12 million new jobs added in 2007, young firms were responsible for the creation of nearly 8 million of those jobs.

Given this information, it is clear that new and young companies and the entrepreneurs that create them are the engines of job creation and eventual economic recovery. The distinction of firm age, not necessarily size, as the driver of job creation has many implications, particularly for policymakers who are focusing on small business as the answer to a dire employment situation.

As we have noted, nearly all net job creation since 1980 has occurred in firms less than five years old. If we want to know more about the dynamics of young companies and how they affect existing companies-and perhaps the sectoral distribution of new companies-we need to look at the data a little more closely. Fortunately, a recent Special Tabulation done by the Census Bureau for the Kauffman Foundation has provided a wealth of information on these very issues, and we will now present some of these findings.

In general, the net addition of jobs from year to year (i.e. job creation) comes from three sources: startups; young firms, ages one to five; and the largest and oldest companies. There is evidently somewhat of a barbell effect, with job creation occurring at the youngest and oldest ends of the firm age spectrum, and mostly flat in between. This isn't the whole story, however, as there is a considerable amount of churn-job creation and destruction-occurring in the youngest companies, as well as an interactive dynamic between the youngest and oldest firms.

Let's begin with startups (defined in the data as "age zero" firms). Over the past thirty years, these newly created companies have served as a primary source of immediate job creation for the economy. A remarkable implication: "excluding the jobs from new firms, the US net employment growth rate is negative on average.”Indeed, without startups, net job creation for the American economy would be negative in all but a handful of years.

But not every startup sticks around-roughly a third will close by their second year of existence, while half will make it to age five. This means the jobs that many firms create at birth will subsequently disappear, so part of their positive contribution to jobs in one year will turn to subtraction in the next few years. No economy could long survive if every year's new jobs were simply eliminated within such a short period. So what about the other half of startups, the fifty percent that survive until age five? This represents our second major source of net job creation. Using the special tabulation from the Census Bureau, we can see that, among existing companies in 2007 ( excluding startups), young firms accounted for the lion's share of job creation-roughly two-thirds, in fact.

What this means is that in 2007, while the largest share of employment remained in the oldest and largest companies young companies, those aged one to five, had been the most dynamic in adding new jobs to the economy. Of the entire pool of new jobs added in 2007 (roughly 12 million), about two-thirds was generated by these young companies.

• If the pessimistic forecasts for how long it will take to recover from the current employment shock are even in the ballpark, we could well be facing a long and slow economic recovery.
• There are various reasons, also, to think that the severity and nature of this recession could seriously dampen new firm formation. If existing companies see little reason to expand their workforce-after all, productivity is rising-why should anyone see fit to start a new company? In a darker vein, will companies formed in this recession be somehow weaker and more prone to failure?
• We have also seen a sharp contraction in credit, particularly commercial loans which, at the time of writing, showed few signs of recovering. Credit is oxygen for new and young firms. If loans are scarce and if household wealth (a big source of financing) has fallen, will new companies be able to raise money?

Virtually all of the attention among policymakers and the media has focused on the waiting game by larger firms, currently reluctant to take back employees they dismissed, and unwilling so far to begin hiring new employees again.

The analysis here, however, suggests this attention is misplaced. The overwhelming source of new jobs is new firms. The key implication for policymakers concerned about restarting America's job engine, therefore, is to begin paying more attention to removing roadblocks to entrepreneurs who will lead us out of our current (well-founded) pessimism about jobs and sustain economic expansion over the longer run. T his much-needed shift in focus cannot come soon enough.

Source: Ewing Marion Kauffman Foundation, Dane Stangler and Robert E. Litan, 11/5/09