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Why Such a Slow Recovery? New Regulations Are Killing Start Ups and New Jobs

by Salim Furth
January 31, 2013

The economic recovery since 2009 has been exceptionally slow and does not match the pattern of previous recoveries. One reason for the recovery-less recovery is that new government regulations combined with tighter credit have made it harder than ever to start a business. Those factors have raised the barriers to entry to new firms, and since start-ups normally create all of the net new jobs in an economy, job creation and investment are slack.


The Slow Recovery

Here’s what we know about the recovery from the 2008–2009 recession:

1. It has been a very slow recovery. Usually, gross domestic product grows fastest right after a recession as it bounces back to trend. Since 2009, GDP has been growing parallel to—but far below—the long-term trend. Employment has remained flat since 2009. Employment dropped drastically in 2008 and has not recovered.


2. Non-residential investment fell by almost 25 percent in two years but has grown steadily since the end of 2009. It has not yet returned to its 2007 level.


3. Corporate profits are booming. Corporations have strong revenues but are not purchasing much capital or labor.


Start-Ups

How can we account for these three facts? An extra piece of the puzzle suggests an explanation: Employment at start-up companies has fallen for five years in a row, reaching unprecedented lows in 2010 and 2011.

Start-ups have been a constant source of new employment in the U.S. economy, hiring about 15 of every thousand working-age American adults every year for decades. Previous recessions featured big job losses from existing firms, but even in recessions, start-up job creation has been a constant—until now.

As economists John Haltiwanger, Ron S. Jarmin, and Javier Miranda show in a 2011 paper published by the National Bureau of Economic Research, most net new jobs come from start-up companies. In 2005, 3.5 million net new jobs were created by startups, while the rest of the economy shed a million jobs. In fact, existing firms rarely create net new jobs. The economy expands by the creation of new firms, not from the expansion of existing firms. Research by economist Tim Kane of the Hudson Institute documents that even in 2008, at the depth of the great recession, new firms created 2.8 million new jobs. But instead of recovering after the recession, job creation by new firms fell in 2009, 2010, and 2011.

Kane shows that hiring by start-ups has slowed to 10 jobs per thousand adults per year, one-third lower than the usual rate. In 2010 and 2011 alone, “missing” start-up hiring amounted to 2 million net jobs. With normal start-up hiring, growth in the employment rate would have been three times as high as it was.


Fixed Costs

Why would business start-ups fade in a period of booming corporate profits? After all, the last two peaks of corporate profitability were both followed by peaks in start-up job creation in 1998 and 2006. And why are corporate profits so strong when the economy is weak?

A simple explanation is that fixed costs, which constitute a barrier to entry to new firms, have gone up in recent years.

With new regulations and business requirements in health insurance, small-business finance, environment, energy, and tax compliance, not to mention the ever-expanding reach of state licensure boards, it is expensive to open a business. In a report published by the Weidenbaum Center at Washington University in St. Louis and the George Washington University Regulatory Studies Center, Melinda Warren and Susan Dudley have calculated how much money the federal government spends to develop and enforce regulations. They calculate that the federal budget for economic regulation increased to $9.2 billion in 2012 from $6.3 billion in 2007. In President Barack Obama’s first three years in office, 106 new major regulations were created (four times more than in President George W. Bush’s first three years), report The Heritage Foundation’s James Gattuso and Diane Katz. Those regulations cost earners $46 billion annually. The biggest new fixed costs come from the Dodd–Frank bill, ObamaCare, and the activist Environmental Protection Agency. In all three cases, enormous discretion is left to regulators to write and implement rules as they see fit. Under arbitrary enforcement, large firms with lobbyists and lawyers have a competitive advantage over unconnected newcomers.

High fixed costs and onerous regulation are textbook “barriers to entry.” Incumbent firms favor many of these barriers, because they keep competitors out of the market, which keeps profits high. In banking, the stringent regulations of the Dodd–Frank Act not only make it hard for small or start-up banks to survive, they discourage banks from lending to borrowers who do not have a strong track record. Less credit for unknown borrowers means fewer start-up jobs created.

Other factors that might discourage competition and firm creation include: elevated uncertainty over the implementation of new regulations, expectations of higher tax rates in the future to pay for rising debt, implicit promises of bailouts for large incumbent firms, and slow demand growth since the recession.


As long as start-ups are held down by bad policy and feckless deficits, incumbent firms can earn profits without expanding supply.


What Policymakers Can Do

Policymakers need to ease entry by new firms. This task can be done at all three levels of government. At the state level, licensure boards should be composed of industry customers, not industry insiders; and licensing requirements should be repealed wherever safe.

At the federal level, Dodd–Frank’s over-regulation of the financial services industry should be repealed, along with its implicit promise of bailouts; and Obama-Care, which was written with input from the largest insurance companies, should be replaced with a sensible health care system based on competition and individual choice.

And at every level of government, regulations of energy use and the environment should be rationalized by taking account of the broad economic impact; small-business regulations that can’t be followed without a lawyer’s help should not be written; and lobbying for special favors and protections should be rebuffed. Generally, big employers in congressmen’s districts do not create net new jobs; their upstart competitors do.


A Bad Environment for Jobs

Entrepreneurs have proven their willingness and ability to start new firms and hire new workers in every economic environment. Only since 2007, in a policy environment that puts government first and people second, has their creativity been slowed. Washington should reverse this trend immediately.


Mr. Furth is Senior Policy Analyst in Macroeconomics in the Center for Data Analysis at The Heritage Foundation. This article is adapted from his Heritage Foundation paper of the same title, published in October 2012.

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