Firm Exit Now Exceeds Firm Entry. That’s a Problem.

For the first time in US history, the rate of firm exit exceeds the rate of firm entry. The new trend represents a shift in our economic structure towards entrenched industries instead of “creative destruction” – or the process by which more productive firms drive out less productive ones through competition. Our economy becomes less competitive when entrepreneurial growth slows.

As Brookings explains: “the level of business deaths kept growing along with the overall level of businesses in the economy, but the level of business births did not”. The decline in “business dynamism” has not been isolated and its decline represents a threat to long-run growth.

What caused this new phenomena? Simply put, firm creation reduces because of increases in the regulatory burden and complex tax law. Both adversely affect small and new firms because they are more cost sensitive than big firms. The latter can navigate through regulations and tax law as well as reduce costs imposed by each.

Since 1997, federal regulatory restrictions have increased 20% and now exceed 1 million. Regulatory accumulation reduces new entrants to industry and inhibits competition.

World Bank economists found that, over a cross-country analysis, industries with naturally high entry have lower entry in countries with more onerous entry regulations. For example, direct regulatory cost in Italy equal 20% of per capita GNP compared to 10% in other G-7 countries. As a result, Italy has a significantly lower annualized long term entrance rate.

In the United States, they find that “relative entry into industries with high entry in the U.S. is disproportionately higher in countries with low entry costs”. This means more competition and growth that fuels the creative destruction function of markets.

The value added by naturally “high-entry” industries grows more slowly in countries with high entry barriers. Entry regulations have these adverse effects primarily in countries that are less corrupt. Taken together, all this suggests entry regulations are neither benign nor welfare improving.

Now, we can visualize the cost passed on from regulatory burdens. For all federal regulation, small firms (less than 20 employees) incur $10,585 per employee and large firms (500+ employees) incur $7,755 per employee. The total costs are estimated to be $1.75 trillion. Environmental and labor regulations are the two biggest drivers.

CONCLUSION: Although there are “good” regulations, burdensome entry requirements reduce the competitive efficiency that is essential to long term growth. Entrepreneurship is an essential part of the American economy and these specific types of regulations are indeed harmful to it.

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