The Unexpected Boom In Startups

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America is currently experiencing what some are calling a "startup boom." That's right — even with a raging pandemic and an ugly recession, America is seeing a boom in the creation of new businesses.

John Haltiwanger, an economist at the University of Maryland, has been working with the U.S. Census Bureau to measure new business creation for decades. Every new business that hires workers, he says, has to apply for an employer identification number with the government, and when the coronavirus pandemic began, the data showed what you might expect: "We saw a collapse in new business applications," Haltiwanger says. But then, about six weeks into the pandemic, the numbers started rising. At first, he says, they had to double-check that the data were correct: "We were, like, what's going on here?"

And then the new business applications just kept rising. "The third quarter of 2020 is the highest quarter of applications we've ever seen," Haltiwanger says (their quarterly data go back to 2004).

Most of these new businesses are seizing opportunities created by the weird coronavirus economy — an economy where people don't really want to do stuff face-to-face anymore. The largest area for new business creation is online retail. Of course, at the same time, we've seen a massacre for brick-and-mortar retail — and we don't know yet whether these new businesses will fill the job void. Moreover, many of the new businesses are just people who were laid off and were forced to strike out on their own. But with these important asterisks, it may be good news that new businesses are growing out of the ashes of old businesses.

Economists have a term for this. They call it "creative destruction." Harvard University economist Joseph Schumpeter developed the idea in his 1943 book Capitalism, Socialism and Democracy. He described it as a process of "industrial mutation ... that incessantly revolutionizes the economic structure from within, incessantly destroying the old one, incessantly creating a new one." He placed it at the center of capitalism, arguing that it was a force that made capitalism much more innovative than socialism.

The U.S., with a more hands-off approach to the economy than Europe, has long been a shining beacon of creative destruction. It's why, many economists argue, America has a dynamic economy that gives the world all sorts of new inventions, products and technologies. The U.S. is now ahead of other rich countries in new business creation during the pandemic.

But there's a big downside to the American approach: unemployment. The U.S. unemployment rate surged to 14.7% in April — and it's now 6.9%, remaining higher than its European counterparts. Germany, for example, has seen its unemployment rate rise only as high as 4.4% during the pandemic.

Germany achieved this using a century-old program called Kurzarbeit, in which the government comes in and helps businesses pay their workers in order to keep the workers employed. We wrote about the benefits of Kurzarbeit back in April.

But Germany doesn't look as hot as America when it comes to the creation of new businesses. And Kurzarbeit and other efforts to prop up existing businesses and prevent creative destruction may be a reason for this. "It is true that Germany has done a better job than the US at protecting *existing* jobs," says economist Jens Suedekum of Heinrich Heine University Düsseldorf. "But one problem that will be with us in Germany for quite a long time is the low rate of new jobs that are being created." Suedekum says this especially hurts young Germans and those workers who get Kurzarbeit benefits during the crisis but are laid off after the crisis.

University of California, Berkeley economist Gabriel Zucman, who wrote in favor of Kurzarbeit back in March, says that he thinks "the jury's still out as to which system — Kurzarbeit or the U.S. system of letting people lose their jobs and get unemployment insurance — is most adapted to the current situation." If the pandemic is short, he says, Kurzarbeit makes more sense because it preserves employer-employee matches and allows companies to rebound quickly in the recovery. But, he says, the longer the pandemic goes on, "the more appealing flexibility becomes."

Whether the German or American approach is better depends a lot on what the world will look like after the pandemic ends. If we go back to a world where people want to shop in brick-and-mortar stores and eat in restaurants with the same frequency, then maybe much of the creative destruction we're seeing in America is actually not that creative. Many of the pandemic startups might be one-off businesses that don't survive when things go back to normal. And then all the economic destruction would be like paying all the costs of moving to a new town only to have to turn around and move back to your old town.

But if we don't return to what the world looked like before COVID-19, a Kurzarbeit-style approach runs the risk of creating "zombie firms," which are businesses that should die but limp along because they're devouring taxpayer money. That can hurt innovation, productivity and economic growth.

In both the German and American systems, the best path to a solid recovery starts with ending the pandemic. But, Haltiwanger says, given our crummy situation, it's still good news for America that new businesses and jobs are being created. His research shows that new businesses create the majority of new jobs in America. The lack of business creation during the Great Recession, he says, was a big reason that it took so long to recover. Fingers crossed it's different this time.

Special thanks to Peter Rashish and Jonathan Hackenbroich for helping us dig through German data.

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