By Peter F. Orazem and John V. Winters
The pace of new firm entry has declined in the United States over the past 30 years. As shown in figure 1, the entry rate, measured as the share of establishments that newly entered in the year, fell from an average of 15.6% in 1978 to 10% in 2000, and to 8.2% in 2019. The declining pace of firm entry has important consequences for employment and economic growth. New establishments are responsible for about one-third of new job creation (Decker et al. 2014). New establishments are also prone to shut down. The survivors are atypically productive, and so a high rate of firm entry and exit is credited with faster productivity growth (Decker et al. 2017). Consequently, slower pace of firm entry is blamed for the slowing of employment and productivity growth since 2000.
Source: Authors’ analysis of US Census Business Dynamics statistics.
Figure 1 also shows that the rate of firm entry has decreased at all county population levels. However, the pace of decline is smallest in the most populous counties. In 1978, the establishment start-up rate was nearly identical in the smallest and largest counties. By 2019, the entry rate had fallen 5.5 percentage points in the smallest counties, but only 4.4 percentage points in the largest counties. As a result, more densely populated markets have the relative advantage in attracting new start-ups over rural areas.
It is possible that the greater decline in entrepreneurship in less populated markets is due to the type of businesses that atypically locate in rural areas. For that reason, we check the relative decline in entrepreneurship by sector in metropolitan and non-metropolitan markets from 2000 to 2022. We change to data on self-employment rates, which shows self-employment rates overall and in agriculture, services, and wholesale and retail trade. We restrict the data to ages 25–64 to focus on the employment decisions of individuals after leaving school and who have not retired.1
Figure 2 shows the pattern of self-employment rates since 2000 for population in metropolitan statistical areas (MSAs) and outside metropolitan statistical areas (non-MSAs). Consistent with figure 1, both metro and non-metro markets experienced decreasing entrepreneurship after 2000. However, the non-MSA markets had higher self-employment rates than did the MSAs.2 As we will see, both the data on establishments in figure 1 and the data on self-employed in figures 2–5 reveal faster declines in entrepreneurship in the less-populated markets.
In 2000, the self-employment rate was 10.8% for non-MSAs and 8.5% in MSAs. The non-MSA self-employment rate began consistently declining after 2004. The MSA self-employment rate began declining in 2008. Both declined significantly during the Great Recession and the slow recovery thereof, but the cumulative decrease was more pronounced for non-MSAs. Self-employment rates appear to have leveled off by 2019 before the onset of the pandemic—the rate was 8.5% for non-MSAs and 7.5% for MSAs. However, 2020 saw notable changes in self-employment rates. The MSA self-employment rate decreased while the non-MSA self-employment rate increased in 2020. This may partially reflect preferences by footloose entrepreneurs to locate in areas less densely populated to better avoid virus exposure and/or lockdowns. It may also reflect increased opportunities to work from home and reduced need for face-to-face interaction. However, the rural entrepreneurship gain was short-lived. From 2020 to 2022, non-MSA self-employment rates decreased from 8.8% to 8.2%, while MSA self-employment rates increased from 7.3% to 7.9%. Thus, 2022 was a historic year for non-metropolitan self-employment rates—they reached the lowest level in recent history and the positive gap in non-MSA to MSA self-employment rates shrank to its lowest level. This has been driven by both persistent long-run declines and recent changes since 2020.
The decline in self-employment rates are somewhat of a puzzle, and we are unable to provide a full explanation. One possibility is that industrial structure may play some role. Compared to MSAs, non-MSAs have larger employment shares in agriculture, manufacturing, and mining, and less in services. Potentially, growth in service sectors related to the sharing and gig economies could increase self-employment and perhaps much more for MSAs than non-MSAs. Similarly, agricultural consolidation could reduce self-employment, with effects heavily concentrated in non-metropolitan areas.
Figure 3 shows metropolitan and non-metropolitan self-employment rates for persons employed in the agricultural industry, broadly defined to include crop production, animal production, forestry, horticulture, and agricultural services. While agriculture is relatively more important in non-metropolitan areas, there is still considerable agricultural employment in metropolitan areas, both self-employment and paid-employment.3 However, the share of agricultural workers who are self-employed varies—it is historically higher in non-MSAs than MSAs, but agricultural self-employment rates have declined for both and the self-employment gap between non-MSAs and MSAs has shrunk. The agriculture self-employment rate in non-MSAs fell from 60.1% in 2001 to 42.6% in 2022; whereas the rate for MSAs fell from 39.2% to 31.3%.
Agriculture is not the only industry driving self-employment trend differences between non-MSAs and MSAs. Figure 4 shows that self-employment rates in services have typically declined for both non-MSAs and MSAs, but the decrease is steeper for non-MSAs. We broadly define services here to include business, professional, personal, and other services but exclude agriculture, transportation, wholesale, retail, and government.4 Services account for roughly half of all employment in 2022. The self-employment rate in services for non-MSAs shown in figure 4 decreased from 13.6% in 2000 to 10.5% in 2022 and from 11.8% to 10.5% for MSAs during this period.
Finally, figure 5 shows self-employment rates in retail and wholesale trade.5 The non-MSA self-employment rate fell from 15.7% in 2000 to 7.5% in 2022, a steep drop. The MSA self-employment rate fell from 12.3% to 8.8% over the same period. The change since 2019 is also especially pronounced. From 2019–2022, the self-employment rate for retail and wholesale decreased from 10.4% to 7.5% in non-MSAs and increased from 8.1% to 8.8% in MSAs.
We also examine self-employment rates in other industries and find them to be more stable over time. Self-employment trends for non-MSAs appear to be driven by agriculture, services, and retail and wholesale trade. It is not clear why exactly these industries are driving the change, but we can speculate. For agriculture, increased mechanization and returns to scale have led to larger farm operations and fewer small self-employed farmers. This is a long-run trend that has especially notable influences on non-MSA self-employment rates since 2000. For services, perhaps many services cannot be efficiently done at small scale by independent business owners in rural areas, facilitating greater market share for large firms. Some services are also tradeable across areas and these services may be increasingly concentrated in metropolitan areas. For example, better information and communication technology may allow rural residents to utilize financial, legal, and business services in urban areas at lower cost or higher quality and reduce the need for those services to be offered by small business owners in non-MSAs. The major decline in retail and wholesale self-employment in non-MSAs may be influenced by increased pressure from e-commerce. Non-metropolitan residents who can access a cornucopia of goods via Amazon.com and other e-commerce options may see less need to buy locally.
The decline in non-metropolitan self-employment amplifies concerns about the future of these areas and how access to goods and services have changed and will change. To the extent that consumers are using technology to better access high-quality goods and services at lower prices, it may be a good thing. However, losing some local businesses to digital competition may have adverse spillover effects for other businesses that benefit from a strong local economy. When one business shutters, it can have ripple effects to others. Additionally, having fewer non-metropolitan entrepreneurs may pose challenges for small town “main street” areas that often serve as gathering places that strengthen social interactions and are highly valued by local residents. Fewer small business owners and reduced demand for commercial space in non-MSAs may also further erode local tax bases that threaten the ability to provide public services. There is still much uncertainty and a mix of possible futures. Some non-MSAs and their people, businesses, and institutions may adapt and not be worse off, but there are also legitimate challenges and concerns involved. Small businesses are important to local areas and declining rates of local entrepreneurs warrants additional attention.
How can small towns attract new firms? Artz et al. (2021) examine the characteristics of Iowa small towns that have had the highest start-up rates since 1994. The most successful small towns had relatively educated populations, higher per capita incomes, more diverse local economies and local availability of customers and input suppliers. These factors were too important to be counteracted by local tax or subsidy policies, and so small towns cannot significantly attract start-ups by offering special tax breaks or incentive packages.
Footnotes:
1The estimates are weighted annual averages computed by the authors from the monthly Current Population Survey (CPS) conducted jointly by the US Bureau of Labor Statistics and US Bureau of the Census and accessed via IPUMS (Flood et al. 2022). We focus on self-employment rates since 2000 because of reduced geographic precision in earlier data. We compute self-employment rates in figure 2 as the percentage of the relevant population that is self-employed, which includes persons not in the labor force.
2The data underlying figure 1 excludes sole-proprietorships without employees. It is possible that less-populated markets have more of these sole-proprietorships.
3In 2022, agriculture accounted for 5.8% of total employment in non-MSAs and 1.9% of employment in MSAs. Note that MSA employment includes many rural workers and farmers who live on the periphery of a metropolitan county. The data do not allow us to distinguish more specifically between urban and rural status, and we usually do not know the specific county.
4We designate industrial codes (CPS variable ind1990) 700-893 in the IPUMS as services. In 2022, 51.8% and 40.7% of employment was in services for MSAs and non-MSAs, respectively.
5In 2022, these industries combined to account for 13.5% of non-MSA employment and 13.0% of MSA employment. These employment shares have changed only slightly since 2000.
References
Artz, G.M., Y. Kim, P.F. Orazem, and P.J. Han. 2021. "Which Small Towns Attract Start-ups and Why? Twenty Years of Evidence from Iowa." American Journal of Agricultural Economics 103(2): 702–720.
Decker, R., J. Haltiwanger, R. Jarmin, and J. Miranda. 2014. "The Role of Entrepreneurship in US Job Creation and Economic Dynamism." Journal of Economic Perspectives 28(3): 3–24.
Decker, R.A., J. Haltiwanger, R.S. Jarmin, and J. Miranda. 2017. "Declining Dynamism, Allocative Efficiency, and the Productivity Slowdown." American Economic Review 107(5): 322–326.
Flood, S., M. King, R. Rodgers, S. Ruggles, J. R. Warren, and M. Westberry. 2022. Integrated Public Use Microdata Series, Current Population Survey: Version 10.0 [dataset]. Minneapolis, MN: IPUMS, 2022. https://doi.org/10.18128/D030.V10.0.
Acknowledgments
We are grateful for partial research support under USDA-NIFA grant 2018-68006-27639.
Suggested citation:
Orazem, P. and J. Winters. 2023. "Declining Firm Entry and Self-Employment in Small Markets." Agricultural Policy Review, Winter 2023. Center for Agricultural and Rural Development, Iowa State University. Available at www.card.iastate.edu/ag_policy_review/article/?a=154.