The Big Idea
Tracking a more dynamic economy
Stephen Stanley | January 27, 2023
This document is intended for institutional investors and is not subject to all of the independence and disclosure standards applicable to debt research reports prepared for retail investors.
One of the striking developments in the wake of pandemic was a spike in people starting their own companies. The lockdowns and migration to work-from-home led to a surge of people launching their own firms instead of working for big corporations. Somewhat surprisingly, nearly three years later that trend has continued. Entrepreneurial activity remains elevated compared to the pre-Covid pace, suggesting that the economy is becoming less centralized, more nimble and perhaps harder to measure.
Business applications and formations
I first examined these statistics in a piece in 2021. As a refresher, the Census Bureau collects data on new business applications. When an entrepreneur is considering starting a new business, he or she usually files with the IRS for an Employer Identification Number, otherwise known as a tax ID. Not all applications eventually become actual new businesses, but a fraction of them do. The business applications series consequently offers a leading indicator of new business formation.
The business applications series spiked early in the pandemic after running in a range of 200,000 to 300,000 from the beginning of the series in the mid-2000s through 2019 (Exhibit 1). Business applications settled back last year but were steady in the vicinity of 420,000 throughout 2022, running 44% higher than the 2019 average.
Exhibit 1: Seasonally-adjusted business applications spiked in pandemic
Not all of these applications eventually lead to an actual new business. The Census Bureau has a model that projects business formations based on the flow of applications and a formula for how likely those applications are to be converted into new businesses. Census Bureau projections of new business formations shows a modest pullback since the early days of the pandemic but a sustained elevated level (Exhibit 2). The figures throughout last year were steady at around 30,000 per month, up about 25% from the 2019 average and noticeably higher than at any time from the Financial Crisis through 2019.
Exhibit 2: Projected seasonally-adjusted business formations
Yelp business openings
A less rigorous but perhaps timelier set of data on new business formations comes from Yelp. The firm compiles new businesses that either post on the Yelp site or are posted by customers. Thus, the data covers only a portion of the economy, focusing on services businesses like restaurants, beauty salons, auto repairs, and home services.
Yelp recently released data for the fourth quarter as well as all of 2022. These data are even more encouraging. New business openings were 567,000 in 2019, 517,000 in 2020, 560,000 in 2021, and then surged to 638,000 last year, up 12% from 2019.
The Yelp data are broken down by sector and geography. Relative to the 2019 levels, the largest increases in new businesses last year came for home services, local services and hotels and travel. In contrast, bars and nightlife, arts and entertainment, restaurants, and shopping and retail fell in 2022 compared to 2019.
Geographically, the new business data were largely consistent with the migration patterns within the country. The fastest growth relative to 2019 came in the South, led by Mississippi, Alabama, South Carolina, Louisiana and Georgia, while the five states that saw a decline relative to pre-pandemic openings were New Hampshire, Oregon, California, Colorado and New York.
While these data are not as comprehensive or as scientific as the Census Bureau figures, they corroborate the notion that new businesses are becoming a growing force within the economy. During the pandemic, it seemed that this might be a temporary phenomenon driven by the unique set of circumstances that Covid brought, but it now looks like the economy may be trending toward more people running their own small businesses.
It is not obvious how the trend toward more small businesses will impact the performance of the overall economy. I would imagine that the economy would prove more dynamic and nimble, as small businesses come and go regularly as demand ebbs and flows and preferences change. This would seem to be a good thing, as capital and labor should migrate more quickly to their most efficient uses.
From a financial market perspective, however, it is conceivable that a more decentralized economy will be more difficult to understand and to measure. For example, payroll employment in such a scenario could come to represent a smaller proportion of all workers. The same would be true for jobless claims. Moreover, to the extent that government surveys for metrics like retail sales and durable goods orders tend to focus mostly on large corporations, some government statistics of economic growth could also come to cover a smaller portion of activity.
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