Should we be worried about business dynamism?
Firms are the engines driving national and regional productivity growth. However, in recent decades, the UK has witnessed shifts within firms that coincide with the slowdown in productivity growth.
Firstly, there’s been a noticeable increase in inequality among firms’ productivity levels, sometimes referred to as greater productivity dispersion. Secondly, there’s been a decline in the churn of firms – fewer new entrants and less movement of jobs between productive and less productive firms.
This decline in business dynamism, coupled with slow productivity growth, is a pressing issue. To reignite productivity growth, it is important that we understand the mechanisms linking productivity and business dynamism.
What is business dynamism and why does it matter?
When economic growth slows and, in particular, productivity growth is weak, a number of things seem to happen concurrently:
- Fewer start-ups and new entrants enter the market – this means less disruption shaking things up.
- With fewer new firms, older firms make up a greater share of the market, and these often exhibit slower productivity growth than new entrants.
- Reduced churn in jobs – firms do not hire quickly, but they also do not fire quickly, meaning people stay where they are.
- Positive productivity events, like new technologies, do not lead to the creation of as many new jobs. Even when firms become more productive, they create fewer new jobs.
This means that business dynamism declines when productivity is weak and this drop poses several challenges. It hampers technology diffusion, limits wage improvements, stifles competition, and fosters market domination by a few firms.
Why has business dynamism declined?
Business dynamism can be measured through metrics like productivity dispersion between firms and job reallocation. Notably, these metrics have also declined in other countries, such as the US and across Europe.
The vast majority of UK businesses (95.7%) have nine employees or fewer. Despite their number, these micro firms account for only a third of employment and 21.5% of turnover. Conversely, there are only 8,000 UK firms, making up 0.1% of businesses, with a staff of at least 250 workers. However, these large-scale enterprises employ nearly 11 million individuals and generate over £2 trillion in turnover. Consequently, these major firms account for almost two in five jobs (39.3%) and just under half of total turnover (47.8%).
Since 2007, the UK has experienced a large increase in productivity dispersion between firms, and even more so when taking the weight of a firm in terms of employment into account.
Job reallocation rate – the rate at which jobs are created, destroyed, or moved within an economy over a specific period of time – has also declined in the UK, as well as in Europe. There have been long-term decreases in start-up activity across many countries, alongside lower levels of high-growth firms. Notably, there also appears to be a fall in the responsiveness of firms within the economy – they are less responsive in terms of job reallocation when faced with changes to their environment, such as technology shocks.
The common trend of declining business dynamism in the US, UK, and Europe suggests global factors are at play, such as weak technology diffusion.
Future focus
While dynamism is crucial, excessive turbulence can be detrimental. Striking a balance between healthy competition and stability is key.
There are important questions to consider:
- How much business churn is good?
- Do policymakers need to create programmes that protect young firms from too much turbulence?
- How can competition be fostered in a modern economy to allow new firms into the market?
Find out more
- Listen to Business Dynamism: is turbulence good for productivity?, an episode of Productivity Puzzles featuring Rebecca Riley, Javier Miranda and John Van Reenen.
- Read chapters 1 and 3 of The Productivity Agenda. Chapter 1 is written by Bart van Ark and Mary O’Mahoney – chapter 3 is written by Stephen Roper.
- Read Firms and Inequalities by Jan De Loecker, Tim Obermeier and John Van Reenen.
- Read Declining Business Dynamism in Europe: The Role of Shocks, Market Power, and Technology by Filippo Biondi, Sergio Inferrera, Matthias Mertens and Javier Miranda.
