Declining Profits, Not Mojo, is Behind Drop in Entrepreneurship

Has the United States lost its entrepreneurial mojo? That’s the conclusion of a recent Wall Street Journal article that chronicles the decline in start-up activity in the United States over the past 30 years.

I disagree. While the article is right on the facts – entrepreneurial activity is on the decline in the United States – it’s wrong on the cause. Americans are creating fewer and smaller start-ups than they used to because running a small business has become less profitable.

Let’s start with the facts. Entrepreneurial activity is down. In 1977, 16.5 percent of American companies were newly founded Census Bureau data show. In 2011, only 8.2 percent were.

Americans created 2.56 new companies with employees per thousand people in 1977. In 2011, they generated 1.31.

Added to this decline in the rate of business formation has been a drop in employment by entrepreneurs. U.S. Census figures show that the average new business had 6.7 employees in 1977. In 2011, the mean number of employees in a new company was only 5.5. Similarly, Bureau of Labor Statistics data show that the fraction of self-employed people with employees has dropped from 20.7 percent in 1995 to 13.8 percent in 2010.

Why the decline in entrepreneurial activity?

The Wall Street Journal thinks Americans have become risk averse, leading fewer of them to start companies. But the data belie the risk-taking story. According to the Flash Euro Barometer, a periodic survey of people in numerous countries conducted on behalf of the European Community, Americans’ attitudes towards the risk of starting a business have changed little in the past 12 years. In 2000, 27 percent of Americans agreed with the statement: “One should not start a business if there is a risk it might fail.” In 2012, that fraction statistically the same – 28 percent.

Let me offer an alternative hypothesis: the decline in entrepreneurship is the result of rational cost-benefit analysis by would-be entrepreneurs. Running a business just isn’t as profitable as it once was. Internal Revenue Service data show that, adjusted for inflation, the net income of the average sole proprietor – who make up three quarters of all people in business for themselves – was 40 percent lower in 2010 (the latest year data are available) than it was in 1977.

The direct comparison of rates of entrepreneurship, small business profitability, and risk taking are compelling. Between 2000 and 2010, the per capita rate at which Americans started new businesses declined by 25 percent, and the income of sole proprietors fell by 23 percent in inflation-adjusted terms, but the fraction of Americans who thought that one should not start a business if there was a risk of failure remained the same.

Americans’ entrepreneurial mojo is still there. But as the profitability of running a sole proprietorship has declined, more and more Americans are directing their mojo elsewhere.

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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.