The paper summarized here is part of the fall 2023 edition of the Brookings Papers on Economic Activity, the leading conference series and journal in economics for timely, cutting-edge research about real-world policy issues. Research findings are presented in a clear and accessible style to maximize their impact on economic understanding and policymaking. The editors are Brookings Nonresident Senior Fellows Janice Eberly and Jón Steinsson.
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An unanticipated jump in business formation during the COVID-19 pandemic may be the start of a trend toward a more dynamic and productive U.S. economy, suggests a paper discussed at the Brookings Papers on Economic Activity (BPEA) conference on September 29.
“We find early hints of a revival of business dynamism; but in many respects it is too early to ascertain whether a durable reversal of pre-pandemic trends is occurring,” write the authors, Ryan A. Decker of the Federal Reserve Board and John Haltiwanger of the University of Maryland.
According to their paper—”Surging Business Formation in the Pandemic: Causes and Consequences?”—applications to the Internal Revenue Service for new Employee Identification Numbers (EINs) briefly plunged early in the pandemic but then rose sharply during the second half of 2020 and remained elevated through mid-2023.
The applications were quickly followed by increases in new locations of existing businesses (establishment births) and new businesses (firm births), and, in turn, by “notable associated job creation,” the paper said, citing Census Bureau and Bureau of Labor Statistics data.
The authors analyzed business formation (both establishment and firm births) by sector, firm size and age, and geographic location. They found a shift in growth during the pandemic from large and mature firms to more dynamic young and small firms. This shift followed two decades dominated by larger firms and characterized by anemic business dynamism, which in turn followed a period of strong productivity growth powered by high-tech startups in the 1990s.
The question the authors pose is whether the pandemic business entry surge will drive a renewed and durable increase in innovation and productivity growth or whether it is largely a reshuffling of economic activity to accommodate more people working from home.
In support of the reshuffling hypothesis, they observed a “donut effect” with business applications increasing more in the suburbs of large metropolitan areas than in central business districts—particularly for service businesses such as restaurants and gyms, reflecting the shift in where people spent their time.
But, in support of the more optimistic interpretation, they note applications and establishment births increased strongly in high-tech sectors likely to fuel innovation, such as online retailing, software publishing, computer systems design, data processing, and research and development services such as artificial intelligence businesses.
They also noted a “tight connection” between surging business applications and employees voluntarily quitting their jobs and only a weak connection between applications and layoffs. They said that suggests workers were moving to new and higher-paying jobs rather than just scrambling for self-employment income to replace a lost paycheck.
“This looks to have been a genuine substantive phenomenon involving a lot of actual job creation,” Decker said in an interview with The Brookings Institution. “This was a real thing.”
However, the authors warn that young businesses started during the pandemic—and their potential economic benefits—may be at risk in the event of a broad slowdown.
“Start-ups are amongst the most fragile businesses,” Haltiwanger said in an interview. “If a significant economic contraction occurs because of monetary policy tightening … that will have some longer-lasting effects on innovation in the future.”
Decker, Ryan A. and John Haltiwanger. 2023. “Surging business formation in the pandemic: Causes and consequences?.” BPEA Conference Draft, Fall.
Acknowledgements and disclosures
The authors did not receive financial support from any firm or person for this article or from any firm or person with a financial or political interest in this article. The authors are not currently an officer, director, or board member of any organization with a financial or political interest in this article.
David Skidmore authored the summary language for this paper. Chris Miller assisted with data visualization.