Surprise: California friendly to new business

Publication Date
Dan McSwain
The San Diego Union-Tribune

A new study finds that California isn’t nearly as hostile to business as its reputation would suggest.

In fact, the state ranks near the top in several key economic measures, such as net job creation and the rate of startups. This is a big deal for two reasons: New businesses create far more jobs than old ones, and California’s high ranking comes despite its onerous costs for taxes, land, energy and other key inputs.

“As it turns out, the cost of doing business isn’t the primary determinant of where businesses locate,” said Chris Thornberg, the founding partner of Beacon Economics and author of the study, which was funded by the research nonprofit Next10. The study was based on Beacon’s analysis of data on business formation gathered by the U.S. Census, the gold standard for the topic.

To be sure, California’s economy has suffered in recent years. And entrepreneurs have suffered right along with it. Yet Beacon found that Golden State woes closely tracked the national recession. Put another way, there’s nothing special about California’s cost structure that has unduly discouraged business formation.

Quite the reverse, it seems.

In 2013, the most recent year with data available, California ranked fourth in the nation with its rate of net job creation (4 percent), or the difference between those created and those eliminated by employers. The only states ranking higher were Delaware, a magnet for corporate headquarters, and North Dakota and Montana, which benefited from booming energy production.

California tied for fourth with Nevada in the rate of job creation by startups (5.5 percent). It tied for fifth with North Dakota in the rate of “establishment entry,” or new operations in a single location that opened in the state (11.4 percent).

In each case, California surpassed Texas, where efforts by political leaders to attract large companies from other states with tax incentives have grabbed headlines and caused hand-wringing about business conditions in recent years.

Sure, Texas is business friendly. And it’s been economically successful. But the evidence that one caused the other is remarkably weak, Thornberg concludes.

Indeed, the Census data illustrate the folly in focusing on large employers, because over time, more than 100 percent of net job creation comes from new companies. That’s partly because new companies tend to kill off established ones, eventually. For every still-growing geezer like Procter & Gamble, there’s a hundred Wang Computers that no long exist.

High levels of such “creative destruction” in the U.S. has fueled higher growth and productivity compared to Europe since the 1800s. But that advantage is eroding, mostly because entrepreneurship has been dwindling in recent decades. 

According to a study released last year, the proportion of firms going out of business has been around 9 percent lately, having bounced between 8 percent and 10 percent for decades.

Meanwhile, the proportion of new firms has been falling, from 14 percent in 1978 to 8 percent in 2011, the most recent year studied.

“Business deaths now exceed business births for the first time in the 30-plus-year history of our data,” concluded the authors, Ian Hathaway and Robert Litan of the Brookings Institution in Washington, D.C.

Research economists have no good answers on how to reverse the trend. Some suggest that the aging population plays a role. As we get older, we tend to lose our appetite for risk-taking.

And California is certainly not immune to the trend of falling net business creation. However, the Beacon study suggests the state is more than holding its own amid secular decline — and has been for decades.

Entrepreneurs are still flocking to the state. Ideal weather certainly plays a role. Probably more important are the powerful network effects in hubs like Silicon Valley for technology and San Diego for life sciences.

Thornberg, the study author, says such upbeat data adds context to the political and chamber-of-commerce types who use the rhetoric of decline to push for lower taxes and fewer regulations.

At the same time, he says it’s no time for California to rest on its laurels.

“We do need to change things in California: We do need to build more housing, we do need to fix our tax system, we do need to reduce some of these regulations,” Thornberg said. “But we don’t need to do them to keep up with Texas. Guess what, we have kept up with Texas.” 

Note: Next10 and Beacon have built an online calculator to compare business dynamism among states.