Bad Grade from Small Business | Eastern North Carolina Now

   Publisher's note: The article below appeared in John Hood's daily column in his publication, the Carolina Journal, which, because of Author / Publisher Hood, is inextricably linked to the John Locke Foundation.

    RALEIGH     Want to know why North Carolina continues to have one of the nation's highest unemployment rates?

    Consider these two facts. First, most net job creation in any modern economy comes from new companies, typically small firms that grow quickly. Second, if you are looking to start a new company in the United States right now, North Carolina is probably not on your short list of potential locations.

    Let's start with the issue of job creation. Some people express the point differently, that small business is responsible for the vast majority of new jobs. That's not quite it. Many small businesses are long-established mom-and-pop operations that don't really add many positions over time. The key driver of employment growth is business starts.

    Because most new businesses fail to survive more than a few years, you might think at first that the rate of business starts in a state may not really be related to economic performance over time. But it turns out that the minority of new companies that do succeed - and the even smaller minority of new companies that succeed spectacularly - account for a surprisingly large share of employment growth. Harvard University economist Edward Glaeser offered this powerful example in a recent City Journal article:

    Consider a good year, 2005, when American firms added 2.15 million new jobs to the economy. Most kinds of companies didn't contribute to that growth; firms between six and ten years old, for example, added about 1.7 million new jobs but destroyed more than 2 million through contractions or closings, for a net job loss of more than 350,000. In almost every age group, job destruction exceeded job creation. The exceptions were two types of firms: the very old and the very young. Firms over 26 years old added slightly fewer than 100,000 jobs, on net, while brand-new firms added more than 3 million.

    Glaeser's analysis revealed a similar pattern for most of the past two decades. Even in 2009, when the nation's economy as a whole shed about 4.7 million jobs, that actually represented the difference between the 7 million jobs lost by existing firms and the 2.3 million jobs created by new firms. Several other studies show that communities with higher rates of new business formation have higher rates of job growth, and the effect intensifies over time. "Without startups," concluded Mercatus Center economist Veronique de Rugy, "there would be no net job creation in the United States."

    Not surprisingly, then, entrepreneurship is strongly associated with measures of state economic growth. Southern Illinois University economist R.W. Hafer found in a 2011 study that a state's rating in the Kauffman Index of Entrepreneurial Activity was "robustly associated" with growth in state GDP and per-capita income. At the international level, the rate of entrepreneurial activity can explain between a third and a half of the variation in national growth rates.

    The key role that entrepreneurs play in embracing innovation, drawing investment capital into new industries, and creating new economic opportunities for others can unlock what might otherwise be hidden relationships between public policy and economic growth. Recent studies show that entrepreneurial activity is particularly responsive to such factors as the marginal tax rate on business investment, the tax rates on inheritance and estates, and the cost of complying with regulation. A 2005 study by economists Steven Kreft and Russell Sobel found that state scores on economic-freedom indexes were strongly associated with state entrepreneurship.

    So why does all this constitute bad news for the North Carolina job market? Well, our marginal tax rates on investment are relatively high. And according to a new survey commissioned for the Kauffman Foundation, entrepreneurs don't think much of North Carolina's tax and regulatory burdens.

    The national survey had 6,000 responding small-business owners, a large-enough sample to allow for state-by-state comparisons. Overall, North Carolina receive a C- for our regulations and a D+ for our tax code, ranking us worst in the South in both categories.

    By the way, Mississippi got a B+ in regulations and an A in taxes. Perhaps another insult or two will make us feel better about that.