The Sagging Fortunes of Young Firms in North Carolina

North Carolina’s economy has become steadily less dynamic over the past several decades.  As previous work by LEAD has shown, our state has clearly seen a deterioration in economic dynamism along several dimensions:

• A declining rate of new firm startups;

• A declining rate of overall hiring and firing (“job churn”) across our state and all of its metro areas;

• Declining rates of job-switching by workers;

• Declining rates of job creation by new and “high growth” firms.

This is a trend affecting the entire nation, and our situation is hardly the worst; recent research published by Brookings found that North Carolina has done better than other states by some measures.  That said, the declining dynamism of our state’s economy remains a cause for concern.

Dynamism and economic growth go hand-in-hand.  A vibrant and ever-changing economy allows emergent businesses to displace their less-productive competitors and enables workers to find jobs that best fit their talents.  A slowdown in this dynamic process of “creative destruction” may cut off an important source of innovation, productivity, and growth in our economy.  This may be one reason why the rate of economic growth has slowed nationwide and in North Carolina in recent decades.

In this article we take a closer look at dynamism trends by focusing on (gross) job creation by young firms.  For the purpose of this article we define “young firms” as those entering or existing in North Carolina for less than six years.  The first six years of a firm’s existence constitutes a highly volatile period of experimentation.  It is during this period that a firm is most likely to fail while firms that survive sometimes grow rapidly.  Because of the intense “creative destruction” occurring during these first few years, examining the fortunes of young firms can shed light on the dynamism of our broader economy.

Young firms have contributed disproportionately to job creation in North Carolina.  Despite representing only 15% of employment on average, they account for 36% of job creation at growing firms.

Like other indicators we’ve examined, the jobs contribution of young firms to fell considerably during the 2007-2009 recession and has not recovered.  Young firms accounted for 41% of job creation in the first quarter of 1996 (the earliest data available) but only 31% in the third quarter of 2015.

North Carolina’s economy has experienced disruptive structural changes in recent decades, including a sharp downturn in manufacturing employment.   However, the changing industrial composition of job creation cannot account for the drop in young firms’ contribution.  In fact, if our industrial makeup had remained unchanged over the past 20 years, we would have seen an even more severe decrease.¹

More troubling signs emerge when we look at individual industry sectors, almost all of which have seen decreasing young firm contributions.  There has been a convergence of industry outcomes over the past 20 years, suggesting a homogenization that may entail slowing reallocation between waning and booming industries.²  There are also worrying signs among some higher-paying sectors.

For instance, the Trade, Transportation, & Utilities; Professional & Business Services; and Leisure & Hospitality industries—which together represented 61% of job creation in the most recent quarter—all saw declines in their young firm contribution.  Professional & Business Services—which started at the highest level—fell the fastest, resulting in a smaller gap between this sector and the others depicted here.  More concerning, this sector offers higher-paying employment on average than the Leisure & Hospitality or Trade, Transportation, & Utilities sectors.

Promoting the growth of “high-tech” industries is a cornerstone of North Carolina’s economic development strategy.³  Although they represent less than 5% of overall job creation, firms in these industries pay high wages and are thought to contribute disproportionately to innovation and growth in the broader economy. Unfortunately, these firms have seen a particularly severe slump in their young firm share of job creation relative to other firms. 

The downward job creation share for young high-tech firms is consistent with productivity trends in this sector; recent research has shown that IT-intensive industries saw exceptional productivity gains in the 1990’s but returned to normal levels of productivity in the following decade, contributing to a broader productivity slowdown.

The information presented in this article provides additional evidence of North Carolina’s declining economic dynamism, a trend which is widespread across industries.  Although the decline in certain residentiary industries (such as Leisure & Hospitality) is unlikely to have broader ramifications, the trends among innovating and high-paying sectors (such as “high-tech”) are more concerning. 

Economists at LEAD and our peers in other research organizations are still in the midst of exploring the nature of declining dynamism in the American economy.  Future research from LEAD will continue to flesh out this story in North Carolina, with a goal of identifying some of the root causes and potential solutions.

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.