COVID-19 hit small businesses particularly hard. The Federal Reserve estimates that 130,000 companies, mostly smaller outfits, closed their doors permanently during the pandemic. So, it is especially encouraging to see that new business formations are surging to record levels, with no immediate end in sight.
The U.S. Census Bureau tracks the total number of applications made to the IRS for a taxpayer ID number, a necessary step in the formation of most business entities. The pace of new business applications initially dipped during the spring of 2020 as the economy was racked by the virus. But by June, applications jumped and pegged out at 551,000 in July, roughly double the pre-pandemic monthly average. And interestingly the trend has continued through June of this year, with each successive month eclipsing any month prior to the pandemic going back to 2004 when data was first collected. Despite the Covid dip, 2020 proved to be by far the greatest year for startups so far and 2021 is lining up to be just as good. There have been an astounding 6 million new business applications filed since the pandemic began.
Tennessee has enjoyed a similar surge, with new business filings with the Secretary of State for the first quarter of 2021 running 55% above the same period last year.
The dramatic uptick in entrepreneurship is particularly encouraging given the decades-long decline in new business formation that has long concerned many economists. The United States experienced a 44% decline in startups between 1978 and 2013 and had seen only a very modest increase through 2019. Many attribute the decline to demographic factors including the aging of the Baby Boom generation, as well as a relentlessly increasing regulatory burden. Accompanying the decline has been a lengthy stagnation in productivity growth as well, limiting potential GDP and wage growth. If sustained, the resurgence of entrepreneurship could be a game changer.
While "steady as she goes" is comfortable for most of us, real increases in productivity and output tend to occur sporadically, unpredictably, and often disruptively. Joseph Schumpeter, a Harvard economist, described these episodic structural shifts with the term "creative destruction" during which significant and sometimes painful shocks lead to innovation and ultimately to greater wealth creation. It could be that the pandemic triggered such an episode.
A recent paper by University of Maryland economist John Haltiwanger suggests such a possibility. Haltiwanger analyzed the Census data and noted some interesting features. Most of the surge in new applications have come from a small number of industry classifications. Fully one third are classified as "non-store retail" (think eCommerce). Trucking and transportation, professional services, construction, and personal services comprise a significant share as well. The pandemic has altered relationships between businesses and workers (telework, suburban migration), as well as between businesses and consumers (online retail, meal delivery etc.). Haltiwanger notes the distinct contrast with the 2008 recession, after which startups continued to decline for several quarters following the end of the recession. The Great Recession was a financial crisis that rendered access to capital scarce in its wake, while the response to the pandemic has flooded the market with capital and suppressed interest rates near zero, providing greater opportunity for entrepreneurs.
We shall see to what degree these major shifts we have experienced in response to the pandemic will remain permanent structural fixtures of the economy, but it is possible that we are in the midst of one of those disruptive periods that lead to more robust growth. Haltiwanger believes the trend has legs, noting that few of us imagined just how radically we could change the way we do business in just over a year.
The rising tide of business formation is of more than academic interest. It is almost an aphorism to say that small businesses are the job creators in America. In fact, according to the Kauffman Foundation, it is new startup business that provides essentially all net new jobs, as large companies on average strive to reduce headcount through cost cutting and consolidation. A continued resurgence in entrepreneurship and innovation, while painful to those caught in the transition, could be just what the doctor ordered to fully recover from the virus.
Christopher A. Hopkins is a certified financial analyst in Chattanooga.