Demographic Origins of the Startup Deficit

"....In 1979, the startup rate—measured as the share of new employers as a fraction of all employers—was 13 percent. In 2007, before the onset of the Great Recession, it was roughly 10 percent, an almost 25 percent decline.....We propose a simple and novel explanation for these patterns. The startup rate is linked in general equilibrium to the pace of labor supply growth, which for reasons largely pre-determined by demographics, slowed dramatically in the late 1970s. Why should labor supply growth affect the startup rate at all? Ultimately, growing labor supply requires growing labor demand, and this can only happen through a decline in the real wage that allows incumbent firms to expand or through entry of new firms. A lesson from models of firm dynamics, starting with Hopenhayn (1992), is that in the long run, free entry ensures that shifts in labor supply are absorbed entirely at the entry margin. Along the balanced growth path of a standard model of firm dynamics extended to incorporate labor supply growth, slower growth in labor supply requires slower growth in the number of firms and thus a lower startup rate.....This explanation fits the data very well. The slowdown in U.S. labor supply growth since the late 1970s explains roughly two-thirds of the declining startup rate; it explains the widespread declines across markets since the labor force growth slowdown affected them nearly universally; and it explains the stability of average incumbent dynamics conditional on their age...."

Fatih Karahan, Benjamin Pugsley and Ayşegül Şahin, "Demographic Origins of the Startup Deficit," Federal Reserve Bank of New York, May 2019, https://www.newyorkfed.org/medialibrary/media/research/staff_reports/sr888.pdf