Exploring Firm Formation: Why is the Number of New Firms Constant?

Recent entrepreneurship research has shed new light on how important new companies—firms less than five years old—are to economic growth, so the next question raised by economists and policymakers might be: How do we increase the number of firm formations? In a review of research into entrepreneurial orientation to help find answers, another important question has arisen: Why does the level of firm formation remain virtually consistent from year to year?

This paper, the second in the Kauffman Foundation Research Series on Firm Formation and Economic Growth, explores this question and makes the following key points:

• Firm formation in the United States is remarkably constant over time, with the number of new companies varying little from year to year. This remains true despite sharp changes in economic conditions and markets, and longer-cycle changes in population and education. While existing entrepreneurship data may miss some numbers of new firms, this does not appear to explain the steady level of firm formation across time.
• Such constancy possibly reflects the nature of the United States economy, employment churn, and demographics. The paper discusses each in detail, as well as entrepreneurial motivations, talent, and the so-called “opportunity recognition” model.
• A steady level of firm formation implies that relatively few factors, such as entrepreneurship education and venture capital, influence the pace of startups, although these factors may help prevent a decline of new firms and may affect specific companies at the margins.
• A closer look at the relatively unchanging number of new firms each year offers potential lessons for public policy, especially when considering the future of entrepreneurship after the Great Recession of 2007–2009.

This paper examines the implications of each of these points, such as possible reasons why firm formation is constant and what it means for the wider economy, why efforts to increase entrepreneurship have not had much effect on the level of firm formation, whether or not the volume of startups really matters to the economy, and how the recession has impacted firm formation.