Possible Insight

Startups, Employment, and Growth

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In regards to my posts on how startups help drive both employment and growth, a couple of people have pointed me to this essay in BusinessWeek by Andy Grove.  He says that:

  1. We have a, “…misplaced faith in the power of startups to create U.S. jobs.”
  2. “The scaling process is no longer happening in the U.S. And as long as that’s the case, plowing capital into young companies that build their factories elsewhere will continue to yield a bad return in terms of American jobs.”
  3. “Scaling isn’t easy. The investments required are much higher than in the invention phase.”

His basic argument is more sophisticated than the typical “America no longer makes things” rhetoric. It boils down to network effect. If the US doesn’t manufacture technology-intensive products, we incur two penalties because we lack the corresponding network of skills: (a) in technology areas that exist today, we will not be able to innovate as effectively in the future and (b) we will lack the knowledge it takes to scale tomorrow’s technology areas altogether.  I don’t believe this argument for all the usual economic reasons, but let’s assume it’s true.  Would the US be in trouble?

Grove makes a lot of anecdotal observations and examines some manufacturing employment numbers.  However, I think it’s a mistake to generalize too much from any individual case or particular metric.  The economy is diverse enough to provide examples of almost any condition and we expect a priori to find specialization within sectors.  We should examine a variety of metrics to get the full picture of whether America is losing its ability to “scale up”.  Bear with me, Grove’s essay is four pages long so it will take me a while to fully address it.

Manufacturing Jobs

First, let’s look at the assertion that we aren’t creating jobs relevant to scaling up technologies.  The real question is: what kinds of jobs build these skills?  Does any old manufacturing job help?  I don’t think Foxconn-suicide inducing manufacturing jobs are what we really want.  Maybe what we want is “good” or “high-skill” manufacturing jobs?  Well take a look at this graph from Carpe Diem of real manufacturing output per worker:

That’s right, the average manufacturing worker in the US produces almost $280K worth of stuff per year.  More than 3x what his father or her mother produced 40 years ago. That should certainly support high quality jobs.  But is the quality of manufacturing jobs actually increasing?  Just check out these graphs of manufacturing employment by level of education from the Heritage Foundation:

This suggests to me that we’re replacing a bunch of low-skilled workers with fewer high-skilled workers.  But that’s good.  It means we’re creating jobs that require more knowledge (aka “human capital” that we can leverage).  Look at the 44% increase in manufacturing workers with advanced degrees!  Contrary to Grove, it seems like we’re accumulating a lot of high-powered know-how about how to scale up.

Manufacturing Capability

Now you might be thinking that we could still be losing ground if the productivity of our high-end manufacturing jobs isn’t enough to make up for job losses on the low-end.  In Grove’s terms, our critical mass of scaling-up ability might be eroding. Not the case.  Just consider the statistics on industrial production from the Federal Reserve.  This table shows that overall industrial production in the US has increased 68% in real terms over the 25 years from 1986 to 2010, which is 2.1% per year.

“Aha!” you say, “But Grove is talking about  the recent history of technology-related products.”  Then how about semiconductors and related equipment from 2001-2010?  That’s the sector Grove came from.  There, we have a 334% increase in output, or 16% per year . Conveniently, the Fed also has a category covering all of hi-tech manufacturing output (HITEK2): 163% increase over the same period, or 10% per year. Now the US economy only grew at 1.5% per year from 2001 to 2010 (actually 4Q00 to 3Q10 because the 4Q10 GDP numbers aren’t out).  So in the last ten years, our ability to manufacture high-technology products increased at almost 7x the rate of our overall economy.  We’re actually getting much better at scaling up new technologies!

I can think of one other potential objection. Lack of investment in future production. There is a remote possibility that, despite the terrific productivity and output growth in US high-tech manufacturing today, we won’t be able to maintain this strength in the future. I think the best measure of expected future capability is foreign direct investment (FDI). These are dollars that companies in one country invest directly in business ventures of another country. They do NOT include investments in financial instruments.  Because these dollars are coming from outside the country, they represent an objective assessment of which countries offer good opportunities.  So let’s compare net inflows of FDI for China and the US using World Bank data from 2009.  For China, we have $78B.  For the US, we have $135B. This isn’t terribly surprising given the relative sizes of the economies, but there certainly doesn’t seem to be any market wisdom that the US is going to lose lots of important capabilities in the future.

Will China outcompete the US in some hi-tech industries?  Absolutely.  But that’s just what we expect from the theory of comparative advantage.  They will specialize in the areas where they have advantages and we will specialize in other areas where we have advantages.  Both economies will benefit from this specialization.  An economist would be very surprised indeed if Grove couldn’t point to certain industries where China is “winning”.  However, the data clearly shows that China is not poised to dominate hi-tech manufacturing across the board.

Startup Job Creation

So we’ve addressed Grove’s concerns about the US losing its ability to “scale up”. Let’s move on to the issue of startups. Remember, he said that startups, “…will continue to yield a bad return in terms of American jobs.”  As I posted before, startups create a net of 3M jobs per year. Without startups, job growth would be negative. If Grove cares about jobs, he should care about startups. The data is clear.

The one plausible argument I’ve seen against this compelling data is that most of these jobs evaporate. It is true that many startups fail. The question is, what happens on average? Well, the Kauffman Foundation has recently done a study on that too, using Census Bureau Business Dynamic Statistics data.  They make a key point about what happens as a cohort of startups matures:

The upper line represents the number of jobs on average at all startups, relative to their year of birth. The way to interpret the graph is that a lot of startups fail, but the ones that succeed grow enough to support about 2/3 of the initial job creation over the long term; 2/3 appears to be the asymptote of the top line.  The number of firms continues declining, but job growth at survivors makes up the difference starting after about 15 years.  For example, a bunch of startups founded in the late 90s imploded. But Google keeps growing and hiring.  Same as in the mid 00s for Facebook.  Bottom line: of the 3M jobs created by startups each year, about 2M of them are “permanent” in some sense.  The other 1M get shifted to startups in later years.  So startups are in fact a reliable source of employment.

I’d like to make one last point, not about employment per se, but about capturing the economic gains from startups. If we generalize Grove’s point, we might be worried that the US develops innovations, but other countries capture the economic gains. To dispel this concern, we need only refer back to my post on the economic gains attributable to startups, using data across states in the US.  Recall that this study looked at differing rates of startup formation in states to conclude that a 5% increase in new firm births increases the GDP growth rate by 0.5 percentage points.

I would argue that it’s much more likely that a state next door could “siphon off” innovation gains from its neighbor than a distant country could siphon off innovation gains from the US: (a) the logistics make transactions more convenient, (b) there are no trade barriers between states, and (c) workers in New Mexico are a much closer substitute for workers in Texas than workers in China. But the study clearly shows that states are getting a good economic return from startups formed within their boundaries.  Now, I’m certain there are positive “spillover” effects to neighboring states.  But the states where the startups are located get a tremendous benefit even with the ease of trade among states.

Conclusion

I think it’s pretty clear that, even if you accept Grove’s logic, there’s no sign that the US is losing its ability to scale up.  However, I would be remiss if I didn’t point out my disagreement with the logic. I’ve seen no evidence of a need to be near manufacturing to be able to innovate.  In fact, every day I see evidence against it.

I live in Palo Alto. As far as I know, we don’t actually manufacture any technology products in significant quantities any more. Yet lots of people who live and work here make a great living focusing on technology innovation.  As Don Boudreaux is fond of pointing out on his blog and in letters to the mainstream media, there is no difference in the trade between Palo Alto and San Jose and the trade between Palo Alto and Shanghai.  In fact, I know lots of people in the technology industry who work on innovations here in the Bay Area and then fly to Singapore, Taipei, or Shanghai to work with people at the factories cranking out units.

Certainly, I acknowledge that a government can affect the ability of its citizens to compete in the global economy. But the best way to support its citizens is to reduce the barriers to creating new businesses and then enable those businesses to access markets, whether those markets are down the freeway or across the world.  One of the worst thing a government could do is fight a trade war, which is what Grove advocates in the third-to-last paragraph of his essay.

The ingenuity of American engineers and entrepreneurs is doing just fine, as my data shows.  We don’t need an industrial policy.

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Written by Kevin

January 23, 2011 at 11:39 am

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