Blog: Firm dynamics and job creation: A perpetual motion machine

Date: 
27/05/2015

The media often reports stories about firms going out of business and the job losses involved. Of course, job destruction is a difficult process, but it’s only part of the story – a large number of new firms and jobs are also created each year. This “churn” in firms and workers is occurring constantly, leading some to describe the process as a “perpetual motion machine”.

Using big data across firms allows us to gaze a little deeper into this turbulence and learn more about these firms and what happens to them over time. A Research Note just published by Productivity Commission researchers Lisa Meehan and Guanyu Zheng highlights a number of interesting insights about employment patterns over the typical life cycle of New Zealand firms.

Each year, a large number of new firms are born – roughly 45 000, or just over 10% of the total firms in the economy. These new firms are mostly small. About 80% are owner-operated and don’t employ any people at all, while only one in a hundred new firms employ six or more people. Because these new firms employ fewer workers than existing firms, they account for only about 2% of total employment.

A large proportion of new firms do not survive for very long at all. For example, of the firms born in 2001, only about 30% were still going ten years on. Small firms are particularly susceptible to going out of business and are less likely to survive than larger firms. Firms are also more likely to exit in their early years. For example, while 25% of firms born in 2001 exited in their first year of operation, a firm born in 2001 that survives to 2010 had only a 7% chance of going out of business in 2011.

Most of the new firms that do survive don’t grow much. The average size of firms born in 2001 that survive for ten years increases from about half an employee to only two employees by the end of the decade. Much of this “on average” growth is driven by a very small number of high-growth firms while the vast majority of new firms do not grow much at all. The smallest firms play an important role in creating new jobs, but this employment growth involves only a very tiny proportion of these firms.

So not only is the vast majority of firms born small, but firms that survive are still overwhelmingly small a decade later and there are very few small firms that transition into large firms. For example, about 80% of the owner-operated firms that were born in 2001 and survived to 2011 still don’t employ anyone after ten years in operation. Only about 4% of these firms grow to have 6 or more employees a decade later.

These general patterns of job creation at the firm level are also seen in other OECD countries. However, New Zealand has a higher proportion of very small firms than most other OECD economies. And because New Zealand firms that are born small are more likely to stay small, New Zealand also has one of the highest concentrations of small old firms in the OECD (see figure below). These small old firms are particularly prevalent in the New Zealand services sector – for example, the financial services and real estate industries.

Average size of start-ups and old firms*

 

Because firm scale tends to reflect the extent of the market, this prevalence for small firms, young and old, is most likely due to small domestic markets coupled with limited trade exposure and connection to global markets. In addition, business owners may be more interested in keeping their businesses small for lifestyle reasons, as highlighted in the recent Westpac Grow NZ business survey. It is also very quick and easy to register a new firm in New Zealand (New Zealand is ranked as the easiest country to start a business in the World Bank’s Doing Business indicator).

The small scale of New Zealand firms and limited scope for “up or out” dynamics whereby young firms either grow or exit the market affects economic performance and is part of the jigsaw forming New Zealand’s poor long-term productivity performance. This, along with other pieces of the puzzle and the broad policy lessons, will be outlined in detail in a forthcoming Productivity Commission Working Paper on “How to lift New Zealand’s productivity growth”.

*Figure source: Criscuolo, C., P. N. Gal and C. Menon (2014), “The Dynamics of Employment Growth: New Evidence from 18 Countries”, OECD Science, Technology and Industry Policy Papers, No. 14.

- Paul Conway, Director Economics and Research

Disclaimer: Blog posts are written by staff members and do not represent the official views of the Productivity Commission.

Published today:

Firm dynamics and job creation in New Zealand: A perpetual motion machine, Lisa Meehan and Guanyu Zheng, Productivity Commission Research Note 2015/1 

New Zealand’s productivity growth: Component and industry decompositions, Athene Laws and Lisa Meehan, Productivity Commission Research Note 2015/1 

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Research

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