August 30, 2016

Business Failure Rates Are Declining


firm exit rate

Many observers have become alarmed by the spike in business failure rates that occurred during the Great Recession.

Jim Clifton, the CEO of Gallup, saw the rise in business closures as a signal of a decline in American small business. In a worried post published on his company’s blog a year ago, Mr. Clifton wrote, “When small and medium-sized businesses are dying faster than they’re being born, so is free enterprise. And when free enterprise dies, America dies with it.”

Wow. That’s frightening rhetoric.

Fortunately, the data from the Census Bureau tells a better story about the survival of American small businesses. Business failure rates and the fraction of American employers that goes under each year is actually in long term decline. In 1977, 12.9 percent of American companies with paid employees went out of business. In 2013, that fraction was down to 9.0 percent.

As the figure above shows, the trend is noisy, with lots of ups and downs. (The R-squared of the linear trend is only 57 percent.) The company closure rate jumps in economic downturns, rising from 12 percent to 14 percent in the 1981 recession; from 10.7 percent to 11 percent in the 1992 downturn; from 11.00 percent to 11.9 percent in the 2002 slowdown; and from 9.9 percent to 10.9 percent in the 2009 recession.

Of course, that’s to be expected. Businesses are hurt when demand slows and consumers and other businesses aren’t spending. Some can’t weather the downturns and go under. But the spikes in business failures are reversed when the economy recovers.

Contrary to Mr. Clifton’s worry that small and medium-sized businesses are failing in droves, the Census data indicate that small employers are less likely to go under now than in decades past.

Over 99 percent of all American companies with employees are small businesses. So the trends shown in the chart are driven by what happens to small companies. And that pattern is clear.

While recessions cause spikes in business failure rates – the long term tendency is toward more, not fewer, small businesses surviving.

Image Source: Small Business Trends, created from Census Bureau data

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Scott Shane


Scott Shane Scott Shane is A. Malachi Mixon III, Professor of Entrepreneurial Studies at Case Western Reserve University. He is the author of nine books, including Fool's Gold: The Truth Behind Angel Investing in America ; Illusions of Entrepreneurship: and The Costly Myths that Entrepreneurs, Investors, and Policy Makers Live By.

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