Friday, August 1, 2014

Changing Dynamics of an Evolving Economy

In March of 2013, I had a short post titled “Entrepreneurship and the Small Business is going to be the Saving Grace of the US Economy”. Well a couple weeks back, I’m reading an Economic Letter from the Federal Reserve Bank of San Francisco, published July 7th, titled “Slow Business Start-ups and the Jobs Recovery”, and it seems to be carrying the same theme as the March 2013 post, albeit more quantitative by design.

The Economic Letter was highlighting the relationship between housing values as a primary source of financing for entrepreneurial endeavors, and the level of new job creation experienced post 2008-2009 recession compared to previous (deep) recessions. 

Things were coming along smoothly until the topic turned to juxtaposing the rates of job creation post-recession for start-ups versus mature firms over time. Comparing cross-sections of the data, we see that indeed start-ups have been responsible for a disproportionately larger share of new job creation versus mature firms when compared to their relative shares of the overall labor market. An observation which has held true for many previous recessions. 

But when the dots are connected over time, a trend starts to emerge, and not a pretty one at that. That ‘Saving Grace’ that I alluded to in the March 2013 post has been losing its luster. Now, being that there are two aspects to this statistic, it’s only fair to consider them both to pinpoint the culprit. Granted both start-ups and mature firms have been – over the same period of time – creating marginally less jobs post-recession, the start-ups seem to have had an exacerbated decline in growth rate.  The overall resulting effect has been a downward trend in the spread of the growth rate of jobs created post-recession by start-ups over that of mature firms. This is of course worrying, as start-ups have historically been the predominate source of job creation growth.


Getting back to the relationship that the Economic Letter was initially highlighting between home equity values and the level of entrepreneurial activity; home equity values have not been reflective of the trend in the growth rate of start-up job creation. Instead, when looking at historical comparisons, home equity values have been trending higher, and this even includes the housing market crash that was associated with or caused (depending on how you look at it) the 2008 Global Financial Crisis. 

In my opinion, the increase over time of home equity values is a function of the continual increase in the housing stock. Even during the deepest and darkest of recessions, we never stop building homes, we just reduce the number that are built. As well as, the US has not had an outright deflationary cycle where asset prices on a broad base fall over time, represented by negative inflation measures.

That being said, the driver of the observed trend in the job creation growth rate of start-ups has to be more fundamental than depressed home equity values post-recession. Little to no real (inflation adjusted) wage growth, paired with increasing labor productivity over the past almost two decades, speaks more closely to what is being observed with start-up job creation.

In a capital-intensive economy like the United States, investments in technology as well as the pernicious death of manufacturing and heavy industrial production, paired with the simultaneous expansion of services and other less labor intensive sectors of the economy is resulting in less marginal demand for labor. Less marginal demand is being represented by a decline in the growth rate of the more sensitive source of job creation, and less of a premium for labor represented in stagnating wages over time, even as labor has been increasing in productivity this entire time.

Here’s [an opportunity for] a silver lining, as waves and waves of baby boomers retire and leave the workforce, and we continue to see the effects of a falling birth-rate on the supply of labor, there may be some upward and well needed pressures on wages. However, technological development does tend to occur at an exponential rate, and I am yet to see a model that forecasts marginal declines in labor supply at an exponential rate.

No doubt, labor productivity will continue to increase-- driven predominantly by technological development-- while the marginal premium placed on that labor will continue to move in the opposite direction.

Best argument I can make for investing in education.

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