In an earlier post, I wrote about the large share of net job creation that comes from new firm formation.
The importance of firm formation to net job creation raises the question: Over time, are newly formed businesses employing more or fewer people? Given the number of net new jobs created from firm formation, a decline in startups’ average employment could pose problems for our economy’s ability to generate the jobs we need to reduce current levels of unemployment.
To figure out what has been happening to the initial employment of new businesses, I took a look at data from the Longitudinal Business Database of the U.S. Census (see figure below). The vertical axis measures the average number of employees per new business in its founding year. The blue bars show the average number of employees in new firms by year. The black line shows the five year moving average of that figure.
The figure shows that the average new establishment founded in 2005 employed about one less person than did the average new establishment founded in the early 1980s (although the numbers are marginally better in 2005 than in the mid-1990s.)
Unfortunately, the Census data is only available through 2005, making it difficult to know if the trend toward lower average firm size it shows is continuing. To see what has been happening more recently, I took a look at Bureau of Labor Statistics (BLS) data. Below is a figure that shows the average number of employees at new businesses established in each quarter from the first quarter of 1999 through the second quarter of 2009. The pattern is a decline in the average size of start-ups, from 6.6 to 4.2 employees.
The number of employees hired by the average new business may be falling over time for any of a number of reasons. But my focus today is not on why the number has declined, but the implications of the decrease. New business formation is an important source of net job creation. Because the average number of employees hired by each new business is declining, we need to create more new businesses every year to generate the same number of net new jobs.
That leads me to a final question: If those additional businesses don’t get formed, will we remain stuck with current high levels of unemployment?