Recent Research: Making the case for more economic dynamism

By its very nature, economic dynamism can unsettle local economies. As businesses dissolve, jobs are lost. Technological shifts can drastically alter – or even replace – companies, occupations and entire industries. As these ripple effects move throughout communities, it is easy to focus on the negative impacts, but this loses sight of the importance dynamism has on national economic health. Recent research highlights the significance of dynamism to individual, state, and national economic well-being, as well as a potential paradox: while many Americans are concerned with too much economic dynamism, research shows that the nation needs more of it, not less.

Dynamism is a broad term that refers to the scale and rate of an economy’s changes across a variety of measures. Since the 1990s, the United States has seen a pervasive decline in dynamism according to the Index of State Dynamism, a new report from the Economic Innovation Group (EIG). The study found the Great Recession accelerated the extent of the decline, with the average state losing one-third of its dynamism.

This interactive index contains seven components to collectively measure dynamism:

• Business churn, measured as the share of all firms in a state that opened in the past year plus the share that closed;
• Change in firms, measured as the annual change in the total number of employer firms;
• Jobs in new companies, measured as the share of total state employment in firms that started in the past year;
• Jobs in incumbent firms, measured as share of total state employment in firms at least 16 years old;
• Labor market churn, measured as the annual job creation rate plus the job destruction rate minus the absolute value of the net change in jobs;  
• Labor force participation, measured as the share of the civilian non-institutional population ages 16 and over that is either currently employed or actively seeking work; and,
• Net domestic migration, measured as the net number of people moving to or from a state per 1,000 residents, excluding movers to and from abroad.

The EIG authors find that 10 states account for more half of the national increase in companies from 1992 to 2014.  The pool of states with the most growth in companies is a radically different group than the one comprising our most populous states, however. The index reveals the Great Lakes Region – home to big states such as Illinois, Michigan, Ohio and Pennsylvania, – experienced the lowest levels of dynamism. States in the Lower Mississippi Valley and New England also exhibit lower dynamism than most of the rest of the country.

The top performing states were all west of the Mississippi River with the exception of third-best Florida. The others, in order of ranking, were Nevada, Utah, Colorado, North Dakota, Texas and California.

EIG also finds that dynamic state economies were generally associated with less manufacturing intensity, a younger demographic profile, a higher foreign-born population share, and a larger share of the population living in a prosperous zip code.

These findings on the long-term declines in dynamism reflect research released by Brookings last year, which found a decline in the dynamism of the U.S. labor market that began as early as the 1980s.  The authors, Abigail Wozniak, Christopher L. Smith, Raven Molloy, and Riccardo Trezzi, found that declines in labor fluidity – the ease with which workers can move between jobs – were smaller in states that saw more workers displaced from routine jobs, suggesting that technological change is not the sole cause of declining dynamism. Recent research also has shown policies such as non-compete agreements, occupational licensing, and land-use laws stifle dynamism.

In Declining Dynamism, Allocative Efficiency, and the Productivity Slowdown, a paper by economists Ryan Decker, John Haltiwanger, Ron Jarmin, and Javier Miranda, the authors find evidence that declining business dynamism has hampered U.S. productivity, and that the post-2000 decline in business dynamism is likely a drag on American living standards. Using firm-level data to deduce several trends on changes in labor productivity in the United States, the authors find that the largest declines in productivity growth were due to inefficient reallocation between existing firms. This suggests “employment and economic output are not flowing to the more productive firms,” as described by Nick Bunker in a Washington Center for Equitable Growth analysis on the study. Bunker also highlights evidence that a decline in new business starts impacts productivity growth, shedding light on the importance of economic dynamism to productivity.

Considerable recent attention in the popular media has been paid to how the rapid pace of technological change that fuels dynamism has affected communities, regional economies, and individual jobs. Based solely on these accounts, one might make the claim that there is already too much dynamism in the U.S. economy. In contrast, EIG notes, “As dynamism has declined, the relative pain for those most impacted by economic change has increased.” Research suggests the U.S. suffers from a lack, not a glut, of dynamism.

This is what is Matthew Slaughter and Matthew Rees from Dartmouth’s Tuck School of Business refer to as the “the paradox of dynamism.” Although concerns regarding economic dynamism – the instability of workforce, the reinvention of skills, and the ensuing sociocultural implications– easily capture substantial attention of the media and local policy makers, economic dynamism is, by and large, good for the national economy.

Ultimately, despite its unsettling nature, EIG notes that dynamism has long played a critical role in the nation’s economic growth. Because declining dynamism has an impact on national, state, and regional economies – as well as the firms and individuals that comprise them – understanding its causes is important for researchers, policymakers, and economic developers. Perhaps more important is a better understanding of what policies and actions may help improve economic dynamism across the United States in a way that is effective, replicable, and equitable.