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The start-ups we don't need: Scott Shane examines a dangerous myth that encourages the creation of too many low-productivity businesses. It's time to change our approach.

Article Excerpt
Policymakers believe a dangerous myth. They think that start-up companies are a magic bullet that will transform depressed economic regions, generate innovation, create jobs, and conduct all sorts of other economic wizardry. So they provide people with transfer payments, loans, subsidies, regulatory exemptions, and tax benefits if they start businesses. Any businesses.

Take, for example, the remarks of President George W. Bush, who said in a speech to the Small Business Week Conference in 2006, "Small businesses are vital for our workers.... That's why it makes sense to have the small business at the cornerstone of a pro-growth economic policy.... The Small Business Administration is working hard to make it easier for people to start up companies. We understand that sometimes people have got a good idea, but they're not sure how to get something started.... And so we've doubled the number of small business loans out of the SBA since I came to office."

This is bad public policy. Encouraging more and more people to start businesses won't enhance economic growth or create a lot of jobs because start-ups, in general, aren't the source of our economic vitality or job creation.

You might be startled by this position, going, as it does, against the grain of most popular arguments. It might even seem illogical to you. After all, companies such as Apple in computers, Microsoft in software, Google in Internet search, and Genentech in biotechnology are all examples of wildly successful start-ups. Federal Express and Wal-Mart were also start-up companies not too long ago. So, surely, these companies must have contributed to economic growth?

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Yes, of course they have. But those companies are not typical start-ups. The typical start-up is a company capitalized with about $25,000 of the founder's savings that operates in retail or personal services. Odds are pretty good that it is a home-based business, and the founder aspires to generate around $100,000 in revenue in five years. So even at the time that Apple, Microsoft, Google, and FedEx were founded, they weren't anything like the typical new business.

To get more economic growth by having more start-ups, new companies would need to be more productive than existing companies. But they're not. A study by economists John Haltiwanger, Julia Lane, and James Spletzer, published in the American Economic Review Papers and Proceedings, combined data from the U.S. Census and other sources to look at the relationship between firm productivity and firm age. The results showed that firm productivity increases with firm age. This means that the average new firm makes worse use of resources than the average existing firm, which is not what you would expect if economic growth benefits more from the creation of new firms than from the expansion of existing ones. And you shouldn't think that the typical start-up makes up for its poor productivity when it gets older, because the typical start-up is dead in five years.

This pattern makes sense: there shouldn't be a positive...

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