Beware the Freelance Economy

Myth: The total number of businesses created is what matters, not the types of businesses that are being created. Reality: I've noticed a disturbing trend in what entrepreneurship in America is becoming. Over the past decade, we have been creating more non-employer businesses and fewer employer businesses per capita. (Employer businesses are companies that the Census Bureau reports have at least one employee; non-employer businesses have no employees.) As a result, the employer business share of the total businesses has slipped four percentage points since 1997, from 26.4% of the total in 1997 to 22.4% in 2007 (see figure to the right). Moreover, there is nothing in the data to suggest that this trend is going to reverse itself anytime soon. Why am I concerned about this trend? Non-employer businesses aren't the source of job or wealth creation that employer businesses are, which means the U.S. economy doesn't benefit as much from them. By definition, non-employer businesses don't create any jobs, and their sales and profits are quite low. So low, in fact, that the Census Bureau's 2002 Survey of Business Owners indicated that only 44% of non-employer businesses were the primary source of income for their owners. To boot, non-employer businesses' are becoming less substantial over time. According to Census data, the average revenues at these firms have declined about 12% in real terms since 2000, when they were less than $50,000 per year to begin with. The rise in the often part-time freelance entrepreneurship (as measured by non-employer business activity) and the simultaneous decline in full-time business creation (as captured by employer business activity) also appears in tax return data. The ratio of business tax returns to non-employer firms has been pretty much the same since 1997, but there are an increasing number of business returns relative to the number of employer firms in the economy. Ignoring the TrendWhile these patterns might result from entrepreneurs creating additional firms for tax purposes, it is more likely to reflect a trend toward a freelance economy. More people are filing schedule C's on their tax returns because they are engaged in part-time entrepreneurial activity, running non-employer firms. Over the past decade, we have ignored the growing share of non-employer businesses, focusing instead on the total number of businesses. Perhaps the shift toward non-employer businesses doesn't matter. Maybe people who used to get part-time jobs to make ends meet now sell things part time on eBay (EBAY) toward the same goal. So all this trend reflects is a change in the form of part-time jobs. But what if people would be more productive in this part-time work if they did it as employees who were part of a bigger organization that could achieve scale economies or other types of efficiency? What if the shift toward non-employer businesses reflects a belief that building a business with employees has become too much of a hassle? Entrepreneurs don't want to deal with issues of health insurance and managing people and all of the things that come with building an organization. So instead they are tending to start more non-employer businesses, with the result that the firms they establish are less substantial and contribute less to employment than the startups created in decades past. Same as It Ever Was?The problem is we don't know why there has been a shift toward non-employer businesses. In fact, we don't even pay attention to the shift because observers often aggregate the two types of businesses and conclude that entrepreneurial activity looks pretty much the same as it always has. Because replacing employer businesses with non-employer businesses isn't necessarily benign, we need to recognize that such a shift has been occurring and figure out why. If something is causing people to forego part-time jobs for less productive part-time self-employment or is causing entrepreneurs to start non-employer businesses instead of employer firms, we need to do something. Looking only at the sum of employer and non-employer businesses and not the share of each might be masking problems in our nation's entrepreneurial system.

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