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Free the Entrepreneurs

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Free the Entrepreneurs

The key to post-Covid recovery is lifting restraints to new business creation. Spring 2021
Covid-19
Economy, finance, and budgets

Covid-19 has destroyed jobs as well as lives. More than 100,000 restaurants and bars closed in 2020, for example, despite the almost $1 trillion federal Paycheck Protection Program. The shift to online retail and the rise of telecommuting due to the pandemic will disrupt even more commerce. The job loss is likely to remain significant for many years. A desperate need now exists for new businesses to open and replace those that have shut down.

Yet standard measures suggest that America’s entrepreneurial energy has been declining for decades. In 1984, a high-water mark for Ronald Reagan–era new business formation, 14.6 percent of all establishments were less than one year old. In 2018, by contrast, only 9.2 percent of all establishments were that new. The declining rate of firm creation did not bring catastrophic increases in unemployment pre-pandemic because the rate of job destruction had also declined.

We must rekindle America’s entrepreneurial imagination, and a post-Covid push for easier business permitting is a natural place to start. The thickets of local business regulations that entangle American localities shouldn’t be allowed to stymie our economic recovery. Cities—where so much American growth is already generated—should set up one-stop permitting shops to get new firms open as fast as possible. And while cities are doing that, the federal government should pay for a cost-benefit SWAT team to make it easier for them to reevaluate their rules and to junk the bad ones. Some regulations could just be dropped for a year, say, to make recovery easier and to learn whether those rules actually do any good.

That Covid-19 would be disastrous for small businesses was clear by the end of March 2020, as the pandemic accelerated in America. The Alignable network includes 4.5 million businesses and regularly polls a subset of its members. I was part of a team of economists that worked with Alignable to use those polls to understand the extent of the coronavirus carnage. We spent some time confirming that the businesses that responded were roughly representative of America’s overall small-business ecosystem.

By early April, 45 percent of the polled entrepreneurs said that they were closed because of Covid-19. Even more shockingly, 37 percent expected that they would still be shuttered in December 2020. The more intangible businesses, like finance and professional services, were more likely to be open; the more physical businesses, including restaurants, were not. Fifty-six percent of eating and drinking establishments in our sample were closed, as well as 70 percent of arts and entertainment venues.

The typical business in the sample had only enough cash on hand to cover two weeks of expenses, so we thought that the dire predictions of mass extinction were plausible. The federal government, however, stepped in with unprecedented largesse. The Paycheck Protection Program first allocated $349 billion for loans to small businesses. These were more like gifts because the forgiveness provisions were so generous. Demand for the loans was enormous. And the distribution was not perfect: banks initially gave the cash to their best customers, rather than to the businesses that had suffered most from Covid-19. Some banks, especially smaller banks, had more PPP cash to pay out per customer. A team of researchers and I compared businesses with preexisting relationships with cash-rich banks to businesses that had banked with cash-poor banks; we estimated that a loan equal to 2.5 months of payroll boosted a firm’s chance of survival by 12 percent. The cash reduced the wave of bankruptcies, though at an astounding cost.

To meet the first tranche’s funding shortfall, Congress delivered a second mountain of money. With that extra $320 billion, the PPP’s total size of $669 billion was almost as large as the entire recovery program that Congress passed in 2009 in response to the Great Recession, and with the third tranche approved in December, it became bigger still.

Probably because of that massive spending, the eventual number of business closures was smaller than many early estimates, including our own. Coresight Research, which specializes in tracking changes in retail, predicted in June that 20,000 to 25,000 stores would shutter in 2020. The eventual number was about 9,000—fewer than in 2019. But 2019 was already something of a retail apocalypse, partly because of the ongoing shift to cybercommerce, and the number of closures in 2020 was more than 50 percent above the 2018 figure.

Many well-known retail firms have gone bankrupt during the pandemic. Few retailers are as iconic as Brooks Brothers, which filed for bankruptcy on July 8, 2020. Few are as glitzy as Neiman-Marcus, which filed on May 7. Ann Taylor, J.Crew, Lord & Taylor, Century 21, Chuck E. Cheese, J.C. Penney, Jos. A. Bank—all went bankrupt in 2020. These companies have assets, especially brand names, that make it likely that they will endure post-bankruptcy, but many less famous companies will have no post-Covid future.

The Internet presents a permanent challenge to brick-and-mortar retail, but before the coronavirus, restaurants were thriving in the electronic age. Between January 2001 and January 2020, U.S. retail employment grew by a paltry 2 percent. Over the same period, employment in eating and drinking establishments rose more than 50 percent. Covid-19 has been particularly brutal for the food-service industry.

Between February and April 2020, employment in restaurants and bars fell more than 49 percent, with 6 million-plus workers losing their jobs. By December 2020, food-service employment nationwide remained down by 20 percent, relative to February. A disease that makes proximity unsafe destroys demand for in-person dining, with or without lockdown regulations, and thousands of restaurants have permanently or temporarily closed because of the pandemic.

According to data derived from the small-business service Homebase, one-third of the food and drink establishments in New York that were open in January 2020 were closed at the start of December. Across the U.S., the National Restaurant Association estimates that, as of December, at least 17 percent of all eating and drinking places—more than 110,000 establishments—were not open for business.

Business closures are not intrinsically bad. In 1942, Joseph Schumpeter famously wrote in Capitalism, Socialism and Democracy that the “process of Creative Destruction is the essential fact about capitalism,” where that process “incessantly revolutionizes the economic structure from within, incessantly destroying the old one, incessantly creating a new one.” Yet creative destruction works to generate prosperity only if new firms arise to replace the old, and America seems increasingly unable to form new companies.

The simplest measure of new-business dynamism is the startup rate, defined as the share of all business establishments formed in the previous year. That measure will count both the formation of new businesses and new factories, branches, and chain restaurants. Between 1984 and 1989, the startup rate ranged from 13.9 percent to 14.6 percent. Twenty-five years later, American entrepreneurial energy appears down by almost 40 percent. Between 2009 and 2018, the startup rate ranged from 9.1 percent to 10.1 percent.

A similar measure is the share of employment in new firms, which stood at 3.9 percent in 2018 and has not moved above 4.4 percent since 2009. Thirty years earlier, in 1988, the share of employment in new firms was 7.4 percent, and ranged between 6.9 percent and 7.9 percent from 1984 through 1989. A far smaller proportion of Americans today work in new firms, and if experience in a startup engenders future entrepreneurship, this might mean a permanent loss in American job creation.

Our country is also far less dynamic in other ways. We move less across space and between firms. More than one-fifth of Americans—20.2 percent—moved into a new home in 1985; fewer than one-tenth of Americans moved in 2019. Between 2007 and 2020, the share of Americans who moved across counties ranged from 3.5 percent to 3.9 percent; between 1983 and 1990, the intercounty mobility rate hovered between 6.2 percent and 6.7 percent. Indeed, from 1950 to 1992, the share of Americans moving across counties never fell below 6 percent a year.

Economists Raven Saks, Christopher Smith, and Abigail Wozniak link declining geographic mobility to parallel declines in mobility across firms, industries, and occupations. Since 1999, Americans have become much more likely to stick with their old jobs, if they’ve got them. The long-term jobless are also rooted in space, often because they’re living with their parents, even when they are over 35.

Many factors doubtless help explain the decline in American dynamism, but regulation seems a major culprit. Building regulations have ensured that housing prices stay high in productive places like San Francisco and New York City, deterring people from moving there for opportunity. In the 1950s, fewer than 5 percent of jobs required an active occupation license, yet by 2016, more than 22 percent of the employed population was licensed. Many of these licenses were for jobs, such as floral arrangement and interior design, that create few or no public-safety risks, unless one considers a bad floral arrangement a public concern. When states require licenses, mobility across occupations and across states is discouraged, especially since not all states offer reciprocity agreements. For example, Texas’s state webpage tells us that the state “does not recognize out-of-state licenses for eyelash extension, hair weaving or wig specialties.”

But regulations that limit new business formation represent the most direct attack on new entrepreneurship. They suppress the entrepreneurship of the poor, which typically involves physical goods, far more than the entrepreneurship of the rich, which often takes place in cyberspace these days. Reducing the bite of those regulations is an obvious step to promote equity and ease the economic recovery after Covid-19.

The story of Facebook’s founding is the stuff of bestsellers and Hollywood, but a key feature of the tale is that the social network was born into a legal no-man’s-land. No regulations interfered with Mark Zuckerberg’s brainchild until it had become an Internet behemoth. Zuckerberg was a Harvard undergraduate and brilliant computer programmer; a less advantaged Bostonian who wanted to start a restaurant or grocery store would face a far thicker web of rules and regulations.

Boston’s “starting a business” webpage has a convenient “how to” section with a button that lets you click “start a restaurant.” This seems promising, but when I tried it in early February 2021, the button led only to the Economic Development webpage for the city, full of cheerful boldface claims such as “we promote policies that help businesses grow while fostering economic inclusion and equity.” If you instead clicked “start a food truck,” you would open the food-truck lottery page, which is somewhat more useful. An older document online contains 18 permitting steps, including one for dumpster placement, a storefront-sign review, and, of course, the “weights and measures inspection.”

New York City’s portal for starting a business is admirably well maintained and clearly displays the business certificates, inspections, licenses, permits, registrations, rules, and regulations that could potentially affect a “food and beverage service” in the city—all 141 of them. Some are understandable, such as the “certificate of fitness for handling, use and storage of flammable, compressed gases.” Others, like the “canopy permit,” or “the electronics store license”—needed before you can sell a single calculator—are more debatable, to put it mildly.

Cities can make it easier for small businesses, post-Covid, by reducing the number of regulations and by making it simpler to comply with existing ones.

Ronald Reagan issued a controversial executive order in 1981 that required cost-benefit analysis before the imposition of any new federal regulations via executive agencies. For the last 40 years, new rules have faced a quasi-independent assessment—the least we should ask. Congressional rules, of course, face no such scrutiny, and neither do local rules. As far as I know, no American city has engaged in either prospective or retrospective cost-benefit analysis before regulating businesses or new construction. Going forward, a commitment to such a policy would slow the relentless expansion of local regulations. Eliminating old rules that fail to pass the cost-benefit test would also make it easier to start businesses.

“Washington should create an impartial cost-benefit-analysis office to provide assessments for states and cities.”

Most cities have too few experts to do all this analysis on their own, but the federal government could help here. Several years ago, Cass Sunstein and I proposed that the national government should create an impartial cost-benefit-analysis office to provide free regulatory assessments for states and cities. The goal would be a relatively impartial, highly professional operation, like the Congressional Budget Office. An external review process would help make these assessments more impartial. A single national office of this kind would enable American cities to draw from a common pool of expertise.

This service wouldn’t control local governments, which would maintain ultimate decision-making authority. But voters could demand such reviews—and expect officials to block or get rid of rules with higher costs than benefits. A federal analysis of local regulations along these lines would cost only a tiny fraction of any major part of the Biden recovery program and, by helping to unfetter local entrepreneurship, result in at least as many jobs.

Localities could also streamline the process of opening a new firm with a one-stop permitting office. In 1996, the military closed Fort Devens in Massachusetts’s Middlesex and Worcester Counties, and the space was converted to civilian uses. Years before the base closed, Governor Bill Weld was trying to rejuvenate the local area’s economy by creating a permitting process less stringent than in most of Massachusetts. Instead of a multiplicity of regulatory agencies, the Devens Enterprise Commission essentially acquired the sole power to authorize new businesses—and a mandate to do so quickly.

One-stop permitting has many attractions. If only one entity guides the process, it will be obvious who is responsible if things get bogged down. If eight agencies have such power, each has seven scapegoats. One-stop permitting shops can ensure that they have people with the right language skills and can deliver a seamless experience.

No academic evaluation has been done of the Devens Commission, but it appears to be quite successful. Just this summer, a nearby newspaper reported that “the Devens Enterprise Zone already has shown that the ability to offer a variety of amenities along with a streamlined permitting process can serve as an economic-development magnet” and that it “has attracted more than 100 companies of all sizes.” There is little risk that any city government could err in making the permitting process too user-friendly.

Covid-19 has been tough on America’s cities and especially on their small businesses. Many will close and need to be replaced. The easiest path toward recovery? Make it easier to start new businesses.

Photo: Roberto Herrett/Alamy Stock Photo

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