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business newsThe Rules of Economics, Part 2
There are two ways you can grow your economy: You can either increase your (working-age) population or increase your productivity. That's it.
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Before we go into the other, more profound implications of our equation, let's visit a few other topics that will give us needed insight into them.
Delta Force
There are two, and only two, ways that you can grow your economy. You can either increase your (working-age) population or increase your productivity. That's it. There's no magic fairy dust you can sprinkle on an economy to make it grow. To increase GDP you actually have to produce something. That's why it's called gross domestic product.
The Greek letter delta (∆) is the symbol for change. So if you want to change your GDP you write that as:
∆GDP = ∆Population + ∆Productivity
That is, the change in GDP is equal to the change in population plus the change in productivity. Therefore, and I'm oversimplifying a bit here, a recession is basically a decrease in production (as normally, populations don't decrease).
Two clear implications: The first is that if you want your economy to grow, you must have an economic environment that's friendly to increasing productivity.
While government can invest in industries in ways that are productive, empirical evidence and the preponderance of academic studies suggest that private companies are better at increasing productivity and producing long-term job growth.
Going to the US for a second, studies show that it's business start-ups that have produced nearly all the net new jobs over the last 20 years. Let's look at this analysis by Vivek Wadhwa.
(Vivek Wadhwa is an entrepreneur-turned-academic. He's a visiting scholar at the School of Information at UC Berkeley, a senior research associate at Harvard Law School, and director of research at the Center for Entrepreneurship and Research Commercialization at Duke University.)
The Kauffman Foundation has done extensive research on job creation. Kauffman Senior Fellow Tim Kane analyzed a new data set from the US government, called Business Dynamics Statistics, which provides details about the age and employment of businesses started in the US since 1977. What this showed was that start-ups aren't just an important contributor to job growth: they're the only thing. Without start-ups, there would be no net job growth in the US economy. From 1977 to 2005, existing companies were net job destroyers, losing 1 million net jobs per year. In contrast, new businesses in their first year added an average of 3 million jobs annually.
When analyzed by company age, the data are even more startling. Gross job creation at start-ups averaged more than 3 million jobs per year during 1992-2005, four times as high as any other yearly age group. Existing firms in all year groups have gross job losses that are larger than gross job gains.
Half of the start-ups go out of business within five years; but overall they are still the ones that lead the charge in employment creation. Kauffman Foundation analyzed the average employment of all firms as they age from year zero (birth) to year five. When a given cohort of start-ups reaches age five, its employment level is 80% of what it was when it began. In 2000, for example, start-ups created 3,099,639 jobs. By 2005, the surviving firms had a total employment of 2,412,410, or about 78% of the number of jobs that existed when these firms were born.
So we can't count on the Intels (INTC) or Microsofts (MSFT) to create employment: We need the entrepreneurs.
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