Author: Andrew Berger-Gross
Economic developers can better position themselves to promote growth in their regions by understanding how the success or failure of individual companies contributes to the health of their regional economy. The increased availability of data on the dynamics of business growth has made it easier for developers and local stakeholders to understand how these “micro” outcomes among particular firms relate to “macro” improvements in their region’s economic condition.
However, we need more than data to draw conclusions about business growth. We also need a theory—an explicit model for describing how the world operates—in order to make sense of the patterns that emerge during data analysis. Many scholars of business dynamics have been influenced by the writings of Joseph Schumpeter, who in 1942 coined the term "creative destruction" to describe how competition between individual firms drives growth in the broader economy. More recent applied work by contemporary economists demonstrates how Schumpeter's theory can help explain the patterns of job growth we see in the data.
In this article we illustrate what the process of creative destruction looks like in North Carolina using firm-level employment data from the Quarterly Census of Employment and Wages (QCEW), which is administered by LEAD in partnership with the U.S. Bureau of Labor Statistics:1
A new firm entering North Carolina is, by definition, a net job creator in any given year. The normal course of events for other firms in the labor market is net job destruction; as a group, these older firms shed more jobs than they add in most years. In this manner, the jobs added by new firms counteract the net job losses typically experienced by the rest of the marketplace.
However, this doesn't mean that every new firm will grow to be successful in the state. On the contrary, the youngest firms experience the highest exit rates. This fact is crucial to understanding the experimental nature of creative destruction. The future prospects of a new firm are unknown when they are first established, but as they set up shop and are tested by the marketplace, lower-productivity firms are more likely to fail (or leave) while higher-productivity firms are more likely to snatch up more market share. New firms serve as a continuous source of fuel into the churning process of job creation and job destruction in North Carolina.
Consequently, firms that survive this experimental process are not only less likely to exit, they also tend to grow larger over time. (The following graph shows the average size of continuing firms – those that “survived” until 2014.)
In sum, the data tell a story that is consistent with Schumpeter’s theory of creative destruction. Now we can start using this theory to further explore key questions about emerging trends in our economy:
For example, we might be concerned that the long-term decline in entrepreneurship is cutting off a critical source of new competitors, while the diminished prevalence of rapidly-growing firms may suggest that highly-productive firms are experiencing barriers to growth (or that low-performing firms are not being forced out of the market.)
What is causing these trends? What implications might these trends have for our overall growth potential? And what can economic developers and policymakers do to combat these trends?
As North Carolina's leading public source of labor market data—housed within the state's leading economic development organization—LEAD is in a very good position to answer these questions. Stay tuned to the LEAD Feed throughout 2016 for continued analysis of the dynamics of business growth in North Carolina, and contact us at any time to learn more about the work we are doing to support our state’s growing economy.
General disclaimers:
Data sources cited in this article are derived from administrative sources and are subject to non-sampling error. Any mistakes in data management, analysis, or presentation are the author’s.
1 This article references longitudinally-linked QCEW data from the Bureau of Labor Statistics Longitudinal Establishment Database. LEAD has access to firm-level data for companies in North Carolina. A firm in our database is counted as "new" when it first appears in the state, while the size of the firm is determined by its employment presence in the state. Note that in this context a "new firm" can be an entrepreneurial start-up, spin-off, or a new branch or relocation from an out-of-state or foreign-owned firm, whereas a "small firm" can be either a small NC-based business or a small branch of an out-of-state or foreign-owned firm. Firm growth is calculated as the difference in employment between March of each year, and firm age is calculated in a manner that controls for changes in establishment ownership following a method outlined by John Haltiwanger et al.