Tiny number of young firms account for most net job creation

Age not size of firms is the key generator of most net job creation in an economy over time and while the typical (median) young firm up to 5 years old creates no net employment (job creation is more than matched by destruction) a tiny proportion provide the jobs engines.

The key role of some young firms in employment has been highlighted by US data and research for several years, and in recent times the Organisation for Economic Cooperation and Development (OECD) has compiled data from several member countries while in Ireland Martina Lawless of the Economic and Social Research Institute (ESRI) had research published on the issue in 2014 when she worked at the Central Bank of Ireland.

Martina Lawless said in her paper:

Using a panel of Irish firms covering almost forty years, we find that younger firms, and entrants in particular, are the largest contributors to the creation of new jobs. Younger firms are consistently more dynamic than older firms and this holds across all size classes, not just amongst smaller firms.

In the US the Kauffman Foundation says that businesses with fewer than 50 employees, which account for 95% of all US companies together with large companies are key players in the economy but neither group contributes to new job creation in the way young, entrepreneurial firms do. In the period 1988-2012, companies more than 5 years old destroyed more jobs than they created in all but 8 of those years.

Researchers at the Kauffman Foundation estimate that firms age one to five account for roughly two-thirds of US net job creation in effect the oldest companies account for the largest share of current employment while — the youngest companies account for the largest share of net job creation (defined as the difference between employment at the beginning and at the end of the five-year period).

In effect, it is not small businesses as a category, that drive job creation but new and young firms.

In Part 1 of this series — Ireland's business startup rate among lowest in European Union — we noted that the share of all US jobs in firms age 16 years or older reached another all-time high (for firms of this age data only goes back to 1993) of 73.6% in 2014, up another half a percentage point over the year — this relates to the declining numbers of young firms and in a special report last September, the Economist said:

The share of GDP generated by America’s 100 biggest companies rose from about 33% in 1994 to 46% in 2013. The five largest banks account for 45% of banking assets, up from 25% in 2000. In the home of the entrepreneur, the number of startups is lower than it has been at any time since the 1970s. More firms are dying than being born.

Most surviving startups remain small while the tiny proportion of transformational entrepreneurs’ startups that do grow — OECD data published in 2016 show an average 4% of all micro startups with a range of 3 to 8% — create a disproportionate amount of new jobs: out of 100 jobs created or destroyed by micro start-ups over a five year window, between 22 (the Netherlands) and 53 (France) newly created jobs come from this group. "The rapid scaling up of a small number of very successful startups is therefore one of the main drivers of aggregate employment growth."

In Belgium, 8% of startups contributed to 51% of jobs created and the 5-year final/initial employment growth rate was 211% with Canada at the top with 227% growth.

OECD data for 18 countries (not including Ireland) published in 2014 show that through the boom to 2007 and afterwards to 2011, the net job creation of young firms dependent on the fast growing cohort, grew each period while at old firms destruction exceeded creation (see charts below).

The OECD says that that most employment growth of new entrants happens in the first 2 to 3 years of activity in all countries, despite significant cross-country differences in the extent to which start-ups continue to grow thereafter.

For instance, in Canada, Spain, and Italy, little or no additional net job creation is recorded on average beyond the third year of activity of the start-up. On the opposite, in countries like Belgium, Netherlands, or Sweden, the ratio of total employment of surviving start-up after seven years (over the initial total employment at the year of entry) is significantly higher than the corresponding value after three or five
years.

The OECD says among small and medium-sized enterprises (SMEs), young firms play a central role in creating jobs and enhancing growth and innovation. On average across all countries and years, young firms account for 17% of employment but create 42% of jobs.

Across all economies analysed, it is only a tiny fraction of startups that actually contribute substantially to job creation. The rapid scaling up of a small number of very successful startups is therefore one of the main drivers of aggregate employment growth.

Source: OECD

The OECD says that the contribution of new firms to the creation of new jobs over their first years of activity can be expressed as a combination of four different elements:

1. start-up ratio, measured as the number of entrants relative to the country’s total employment;

2. survival share, measured as the number of units that survive over the first years of activity over the total number of starting units;

3. average size at entry, calculated as the average number of employees for entrants;

4. average post-entry growth, measured as the final over initial employment ratio of surviving entrants.

In the majority of countries surveyed by the OECD, the survival rate is equal to just above 60% after 3 years from entry; it falls to about 50% after 5 years, and to just over 40% after seven years. Furthermore, it appears as a striking regularity across many countries that the probability of exiting is highest when businesses are two years old, and decreases (linearly) beyond that age.

Source: OECD

Falling startup rates

In the US, new businesses represent a falling share of the business community. According to Census data, new firms accounted for as much as 16% of all firms in the late 1970s. By 2011, that share had fallen to 8% and remained so in 2014.

Not only are there fewer new firms, new startups are creating fewer jobs. The Kauffman Foundation says that the gross number of jobs created by new firms dropped by more than 2 million between 2005 and 2010.

The OECD says that the US trend "is broadly true for most OECD countries over the last 15 years. Although the causes of this trend are still being debated, the evidence points to policy as one factor, which appears to hamper startup entry and subsequent growth."

Giant companies in sectors are becoming bigger while cash-rich companies like Google buy innovation by acquiring startups with potential. For example Facebook acquired WhatsApp for $19 billion when the young firm had just 20 employees.

Source: OECD

Part 3 will investigate if high-growth firms are overrepresented in high-tech industries?