The High-Tech Sector is Less Dynamic: Here's What That Means, and Why It Matters


This post originally appeared in Harvard Business Review

Believe it or not, America’s high-tech sector has become less dynamic and less entrepreneurial in the last decade. That’s the key takeaway of a recent Kauffman Foundation report I co-authored.

Despite the fanfare this vital segment of the economy and its startups have received in recent years, the high-tech sector is experiencing a consolidation of activity away from young firms into more mature ones, and the pace of job creation has been on a persistent decline. While it’s true that high-tech companies have been well-represented among the fastest growing firms in the past few years, the high-tech sector--like the rest of the economy--is less dynamic overall.

What do I mean by “dynamic”? The study of business dynamism involves measuring the flows of firms and workers underlying the private economy. Businesses are constantly being formed, growing, shrinking, and closing. Labor markets reflect this churning: some jobs are created while others are destroyed, and some workers move into new roles as others seek to replace them. New and superior ideas replace existing and inferior ones, while more productive firms usurp less productive ones.

A particularly important part of this dynamic process is the entrepreneur, who starts a venture to create a new market, or to replace incumbents in an existing one. And entrepreneurs also play an outsized role in new job creation. While older and larger firms account for the substantial majority of employment levels, new and growing young firms drive net new job creation overall.

The process of business and labor market churning is a messy one. But it’s also fundamental to modern economies. Research has firmly established that this process of “creative destruction” fuels productivity growth, making it indispensable to our sustained economic prosperity. In other words, a more dynamic economy is a higher growth one.

But business dynamism is breaking down.

Forthcoming research from economists at the University of Maryland and the Census Bureau shows that business dynamism has been declining across a broad range of sectors during the last few decades--and the single biggest contributor is a declining entrepreneurship rate. A host of indicators point to a workforce that has become more risk-averse, and therefore less likely to change jobs or start a new venture.

I recently teamed up with two authors of the aforementioned research to produce the Kauffman report: John Haltiwanger of the University of Maryland, and Javier Miranda of the Census Bureau. We surveyed how these trends might apply to the high-tech sector. What we found surprised me.

Though the high-tech sector was particularly dynamic and entrepreneurial during the 1980s and 1990s--a period when the same was not true across a broad range of sectors--all that changed in the 2000s. The job creation rate (representing expanding firms) has been on a sharp decline since the beginning of the last decade, while the job destruction rate (representing contracting firms) has held about steady--squeezing net job growth in the process. By 2011, the rate of overall labor market churning in high-tech had converged with the rate for the total private sector.

Even more striking was the declining entrepreneurship. Young firms that I’ll call “startups”-- those aged five years or less--comprised 60 percent of all high-tech firms in 1982. That figure fell to 38 percent by 2011. About half of this decline took place after the dot-com bust dissipated. The decline in both entrepreneurship levels and rates during the period associated with the Great Recession were sharper in high-tech than for the rest of the economy.

A decline in high-tech dynamism might be particularly problematic for future growth. Aside from the direct impact on productivity in technology-adopting segments of the economy, the high-tech sector itself plays an outsized role in income, employment, and productivity growth overall. Of the job-creating young firms, high-tech startups are particularly dynamic--growing at twice the rate of a typical young business, and high-tech firms account for an outsized share of America’s fastest growing businesses--the so-called “gazelles.”

To be clear, our data were last collected in March 2011 and our definition of high-tech stretches beyond software and internet companies to include things like computer hardware, life sciences, and aerospace. Still, investments in early-stage firms haven’t exactly been explosive in the last two years, and the recent boom of high-value venture-backed exits--either through acquisition or IPO--were generally companies hatched long before our lapse in data. Market participants I talk to think my observation of an uptick in high-tech firm starts in 2011 accelerated in 2012 before plateauing in 2013. That appears consistent with one recent analysis of high-tech job growth.

This work may pose more questions than answers, but as economists are working to uncover these, we can be asking ourselves what we can do to promote technology entrepreneurship right now--which, although popular, may not actually be booming at the level the media would have you believe.