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Entrepreneurship is the Key to Economic Growth and Job Creation

John Dearie | 05/29/2014 |
Carlos Cruz/CC

Three reports issued in recent weeks provide important, and worrisome, insight into the long-term health of the U.S. economy. If policymakers carefully consider each—and understand the connections between them—the U.S. economy stands a far better chance of returning to historical rates of economic growth and job creation. 

Report #1: On May 7th, the Labor Department reported that productivity—output per hour worked—declined at an annual rate of 1.7 percent in the first quarter of this year. After growing at an average annual rate of about 2.5 percent since 1948, productivity growth has averaged only about 1.1 percent since 2011—less than half the historical trend. 

The flagging rate of productivity growth is cause for concern because productivity drives economic growth and rising standards of living. In 1956, Nobel Laureate economist Robert Solow demonstrated that most of economic growth cannot be attributed to increases in capital and labor, but only to gains in productivity—gains driven by innovation. As businesses and workers become more efficient, costs fall, profits and incomes rise, demand expands, and economic growth and job creation accelerate. 

Throughout modern economic history, entrepreneurs and the start-ups they launch have been the principal source of the innovation that drives productivity gains. For example, most of the radical innovations of the past 100 years—electrification, the railroad, the automobile, the airplane, the telegraph and telephone, air conditioning, the computer—the truly “disruptive” innovations that dramatically enhanced productivity and fundamentally re-made the economic landscape, came from entrepreneurs. Relatedly, recent research has demonstrated that start-ups have also accounted for virtually all net new job creation over the past three decades.

Report #2: Alarmingly, entrepreneurship in America is in trouble. In an important new paper released by the Brookings Institution on May 5th, economists Robert Litan and Ian Hathaway show that new business formation and businesses dynamism—the economically vital process by which firms continually launch, expand, contract, and fail—has been in persistent decline over the last few decades across a broad range of industry sectors, including high-technology, and in all 50 states. Given the critical role start-ups play as the principal source of innovation and job creation, this multi-decade decline in business dynamism is nothing short of a national economic emergency.

What might account for the decline in American entrepreneurship? 

At roundtables we conducted with entrepreneurs in 12 cities across the United States, I and a colleague, Courtney Geduldig, heard a number of major themes everywhere we went—remarkable, given the size and diversity of the U.S. economy. One recurring message is that regulatory burden, complexity, and uncertainty is undermining entrepreneurs’ ability to successfully launch new businesses, expand, and create jobs.

“They can be federal, state, or local—and sometimes they conflict,” Alan Blake of Austin-based Yorktown Technologies told us. “Identifying, understanding, and complying with all these regulations is a huge loss of productivity…Entrepreneurs don’t have the resources to hire an in-house counsel or a chief financial officer. They're trying to do all of it themselves.” 

“It’s as if the politicians and regulators in Washington want me to fail—and spend all their time thinking up new ways to ensure that I do,” said Sharon Delay, founder of Adjunct Solutions in Westerville, Ohio. “Quit throwing ridiculous roadblocks in front of me! You either want me to be the engine of the economy or you don’t!” 

Report #3: “10,000 Commandments,” an annual assessment of the Federal regulatory burden compiled by Wayne Crews of the Competitive Enterprise Institute, issued on April 29th, confirms that the message from our roundtables is more than mere carping. Last year more than 3,600 new regulations were finalized and an additional 2,600 were proposed. Nearly 90,000 new final regulations have been promulgated over the past 20 years—an average of more than 4,300 each year. Crews estimates the overall cost of regulatory compliance and its economic impact to be $1.9 trillion annually—equivalent to the tenth largest economy on Earth.

To be sure, regulation is essential to market economies. It establishes the rules of competition, ensures a level playing field, governs participants’ behavior, and protects consumers, public health and safety, private property, and environmental resources. 

But regulation is not free, or without consequence. Regulation imposes costs—costs borne principally by businesses. Regulation can also create economic distortions, entrenched interests, and powerful constituencies, and can lead to cronyism and dependency. In short, if overdone or unwisely implemented, regulation can cease to be a facilitator of economic activity and, instead, become an obstacle. 

The stifling effect of over-regulation is particularly acute for fragile start-ups, which lack the resources and scale of large firms over which to absorb and amortize the cost of compliance. A 2010 study by the Small Business Administration found that regulatory compliance costs small businesses 36 percent more per employee than larger firms. 

Pointing out that the sheer accumulation of regulations over time, like barnacles on a boat, can begin to suppress innovation and growth, Michael Mandel and Diana Carew of the Progressive Policy Institute have proposed creating a “Regulatory Improvement Commission” (RIC). Modeled on the Base Realignment and Closure (BRAC) Commission, the RIC’s mission would be to serve as a mechanism for the regular evaluation, simplification, streamlining, consolidation, and even elimination of selected regulations, subject to an up or down vote by Congress.

Last Tuesday, legislation to create the RIC, the Regulatory Improvement Act, was introduced in the House of Representatives by Reps. Patrick Murphy (D-FL.) and Mick Mulvaney (R-SC). Similar legislation was introduced in the Senate by Senators Angus King (I-ME) and Roy Blunt (R-MO) last July. 

To tackle many of our nation’s most pressing challenges—the ongoing jobs crisis, our long-term debt, stagnant middle-class wages, the income and opportunity gaps—America needs faster economic growth. Start-ups drive innovation, which drives productivity, which drives economic growth. Passage of the Regulatory Improvement Act would amount to a powerful economic stimulus by reducing regulatory burden, complexity, and uncertainty for all U.S. businesses and, perhaps most importantly, by promoting the survival and growth of America’s engine of innovation and job creation—start-ups.

 

John R. Dearie, Executive Vice President at the Financial Services Forum, is co-author, with Courtney Geduldig, Vice President of Global Regulatory Affairs at McGraw Hill Financial, Inc., of “Where the Jobs Are: Entrepreneurship and the Soul of the American Economy,” published by John Wiley & Sons. You can follow him on Twitter here.

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