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Why America Stopped Being a Startup Nation

Noah Smith is a Bloomberg View columnist. He was an assistant professor of finance at Stony Brook University, and he blogs at Noahpinion.
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For years now, economists have been warning that something seems very wrong with the fundamentals of the U.S. economy. We think of the U.S. as a dynamic country of entrepreneurs and independent business owners, but this is a lot less true than it used to be. As economists Ryan Decker (now of the Federal Reserve Board) and others have demonstrated, the rate at which new businesses start up in the U.S. has been in decline. Up until 2000, most of that decline was the result of big chain stores and restaurants pushing out local mom-and-pop businesses. But since the turn of the century, high-growth companies are also forming at lower rates. The Silicon Valley startup boom we read about in the news is the exception, not the rule.

What is the reason for this troubling trend? Many explanations have been proposed, but one favorite theory on the free-market right is that government has been choking off entrepreneurialism with a thicket of regulation. For example, Ryan Streeter, director of the Center for Politics and Governance at the University of Texas-Austin, writes:

A probable explanation [for the decline in dynamism] is that a steady accrual of rules and regulations for years has effectively eliminated a generation of entrepreneurs as the costs of running a new enterprise outweigh the benefits. The good news is that there is an antidote: increasing economic freedom...Regulations implemented over the past seven years alone amount to a $100 billion tax on the economy...Small business owners now rank regulations on par with taxes as the single biggest threat to their growth.

This story is seductive, because it fits with libertarian and conservative distrust of government. Regulation is also easy to blame because there are so many different kinds, and because so many government rules are obviously produced by lobbying and political influence-peddling. In fact, if free-market types were ever to shift their focus from tax cuts to deregulation, that would make me very happy.

That said, there is reason to doubt that regulation is the main culprit behind declining dynamism. A 2014 paper by Nathan Goldschlag and Alex Tabarrok of George Mason University provides some evidence that rebuts Streeter’s thesis.

The stringency of regulation is hard to measure, so Goldschlag and Tabarrok make use of RegData, a relatively new database of regulatory strength created by the Mercatus Center, a libertarian-leaning think tank. RegData is created by going through the Code of Federal Regulations and counting the number of times words such as “must,” “may not,” and “prohibited” are used. These restrictive-sounding words are then matched to various industries to which they apply, using machine-learning techniques. It’s an ingenious way to turn something qualitative (federal laws) into a quantitative measure.

Goldschlag and Tabarrok find that regulation has increased quite a lot in most industries, especially in manufacturing:

But correlation doesn't equal causation. If the increase in regulation is causing the decrease in dynamism, we would expect that industries where the former has been greater to have experienced more of the latter.

When Goldschlag and Tabarrok run the numbers, however, they find no measurable relationship between rising regulation and declining dynamism at the industry level. Sectors where rules have become increasingly stringent have seen declines in startup rates that are no greater than sectors in which the level of regulation has been little changed.

The authors look within the manufacturing sector, where regulation has increased the most, and they find the same thing. Manufacturing industries that are more heavily regulated than in years past have had roughly the same rates of new business formation:

Nor are changes in job creation and destruction -- other measures of an industry’s dynamism -- correlated with the changes in regulatory stringency.

It’s important to note that Tabarrok himself is a famously libertarian-leaning economist, and the Mercatus Center has a free-market ideological bent. So this paper isn't merely a case of pro-regulation people pushing their own agenda and Goldschlag and Tabarrok’s paper is a stern rebuttal to those who claim that economists’ results are driven by their ideology.

Now, this one paper doesn't prove that regulation isn't the cause of decreasing dynamism. The RegData database measures only federal regulations, not state and local ones. Additionally, RegData’s method of measuring the stringency of regulation may be flawed; the same could be true of its algorithm for matching regulations with industries. More studies will have to be undertaken before we can decisively rule out regulation as the culprit. But in the meantime, pundits should probably think twice before declaring confidently that government is the reason Americans seem to have lost the entrepreneurial spark.

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

To contact the author of this story:
Noah Smith at nsmith150@bloomberg.net

To contact the editor responsible for this story:
James Greiff at jgreiff@bloomberg.net