Author: Andrew Berger-Gross
Competition between individual companies helps drive growth in North Carolina’s overall economy as productive firms displace their less-productive competitors. Previous work by LEAD has demonstrated the importance of new firms in this process of “creative destruction”.
In this article, we will also consider existing (i.e. not new) firms undergoing periods of rapid employment growth, known as “high-growth firms” or “gazelles”. These firms are thought by business researchers to play a key role in creative destruction due to their disproportionate rates of job creation.
Following the definition employed by the Organization for Economic Cooperation and Development (OECD)1, we identify “high-growth firms” as existing firms starting with 10 or more employees and growing at least 72.8% over a three-year period (not counting job gains from mergers or acquisitions). We define “new firms” as those entering North Carolina within a three-year period.2
Using firm-level employment data from the Quarterly Census of Employment and Wages (QCEW), we can clearly see that new firms (as a group) generate more new jobs than high-growth firms during any given three-year period. High-growth firms do represent a smaller share of all firms—around 1% in a typical three-year period, versus around 30% for new firms—and thus punch far above their weight when it comes to job creation. However, their overall jobs contribution is less substantial.
The “other” category—firms that are neither new nor growing rapidly enough (or starting from too small a base) to be defined as “high-growth”—has increased in importance over time. Although new and high-growth firms have historically represented the majority of job creation in our state, their importance declined considerably during and after the Great Recession. The percentage of job creation accounted for by new and high-growth firms declined from 59% in the first quarter of 1993 to 45% in the second quarter of 2015 (the earliest and most recent dates available).
Does the declining jobs contribution of new and high-growth firms herald a “new normal” for North Carolina’s economy? And if so, does our current state of affairs portend poorly for our long-term growth prospects?
A number of economists who have been following these trends at the national level express concern that the fall-off in new and fast-growing companies is hampering more than short-term job creation. These trends may also signify a declining dynamism in the wider economy, which can serve to short-circuit long-term growth if it leads to a drop-off in the innovative products and process efficiencies that new and growing firms introduce.
Researchers are still in the early stages of exploring the changing role of new and high-growth firms in our economy. Although we are seeing declining rates of productivity growth nationwide, it is difficult to quantify the degree to which a slowdown in business dynamism is a factor.
It is possible that new and growing firms are continuing to innovate and expand their market share but the increased prevalence of outsourcing and automation has meant that new jobs are not needed to fuel this growth. It is also possible that as older, established firms become more prevalent and more important for job creation, these mature firms could be picking up the slack by conducting “entrepreneurial” activities within the boundaries of their own businesses.
However, any explanation that casts the recent decline in job creation by new and high-growth firms in a positive light is little more than speculation at this stage. Historical experience suggests that we should be concerned about the recent data on new and high-growth firms, which have traditionally been engines of job creation and innovation in our economy. LEAD will continue to investigate these trends in the months ahead.
General disclaimers:
Data sources cited in this article are derived from administrative records and are subject to non-sampling error. Any mistakes in data management, analysis, or presentation are the author’s.
1 Work by other researchers has shown that the group of firms identified and the manner in which they impact the economy is highly sensitive to the precise definition of “high-growth” used. However, whatever the definition, “high-growth” firms have a disproportionate influence on the economy.
2 This article references longitudinally-linked Quarterly Census of Employment and Wages (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 the third month of each quarter. Both firm growth and firm age are calculated in a manner that controls for changes in establishment ownership following a method outlined by Haltiwanger et al.