Why American business is stuck in neutral

The United States has rightly regarded itself as a land of entrepreneurs, where it is easier than elsewhere to found companies and then, if you are lucky and determined, to turn those companies into giants. Many of America’s greatest entrepreneurs came from nowhere to build giant businesses: Andrew Carnegie was a penniless immigrant and John D. Rockefeller was the son of a snake?oil salesman. Many of America’s most successful business people built their fortunes by satisfying the desires of ordinary people: think of Sears and Roebuck building a giant mail?order system to deliver goods to isolated farmers or Ray Kroc building an empire on buns and burgers. In Britain, great entrepreneurs celebrated their success by winding down their businesses and buying an estate and a title. In America, there is no higher aristocracy than the aristocracy of entrepreneurs.

But Americans are finding it harder to start companies than they did a generation ago and harder still to grow those companies once they have started them. The share of all businesses consisting of young firms (aged five years or younger) declined from 14.6 percent in 1978 to just 8.3 percent in 2011, even as the share of firms that were going out of business remained roughly constant at 8 to 10 percent. The share of total employment accounted for by young firms declined from 18.9 percent in the late 1980s to 13.5 percent just before the great recession. The proportion of people younger than thirty who owned stakes in private companies declined from 10.6 percent in 1989 to 3.6 percent in 2014.11

The decline of creation has even extended to the tech sector. The number of young tech firms has declined since peaking in 2000. The number of IPOs has plunged—from an average of 547 a year in the 1990s to 192 a year more recently. In the 1990s, tech entrepreneurs used to dream of taking their companies public and becoming the next Bill Gates. Today they dream of selling their companies—or at least their bright ideas—to one of the established tech giants. They are supplicants to the established order rather than radical disrupters.

At the same time, the biggest companies are consolidating their hold over the commanding heights of the economy. Apple, Google, Amazon, and their peers dominate today’s economy just as surely as U.S. Steel, Standard Oil, and Sears, Roebuck and Company dominated the economy of Roosevelt’s day. The Fortune 100’s share of the revenues generated by the Fortune 500 went up from 57 percent to 63 percent between 1994 and 2013.

The expansion of big companies and the decline in the rate of company creation means that the economy is becoming significantly more concentrated. The number of U.S. listed companies nearly halved between 1997 and 2013, from 6,797 to 3,485. The Economist divided the economy into nine? hundred?odd sectors covered by America’s economic census. Two? thirds of them became more concentrated between 1997 and 2012.

The decline in the rate of company creation since the 1980s does not necessarily indicate a decline of entrepreneurialism: lots of small companies are me?too enterprises that don’t do anything to raise productivity. The United States saw an increase in the number of startups that went on to revolutionize their industries, such as Microsoft, Amazon, and Google. Established big companies such as John Deere also became more entrepreneurial.

Nor is concentration proof of predatory monopolies. Joseph Schumpeter argued that concentration can be both a cause and a consequence of success. Successful companies race ahead of their rivals in order to enjoy the advantages of temporary monopolies. They invest the superprofits that they gain from those temporary monopolies in more R&D in order to stay ahead in the race. Great firms “largely create what they exploit,” as he put it.

That said, there are reasons for deep concern. Companies are protecting themselves from competition by building all sorts of walls and moats. This is particularly true of the tech giants. They are using network effects to dominate markets: the more people you have in your network, the more valuable those networks are. They are using convenience to squeeze out potential rivals: iPhones work easily with iPads, for example. They are highly aggressive in buying up patents and suing rivals for patent infringements.

There is growing evidence that consolidation is slowing the rate of the diffusion of innovations through the economy. Schumpeter argued that one of the reasons capitalism is so dynamic is that successful businesses stand on ground that is “crumbling beneath their feet.” Fast followers are always “stealing” your secrets and improving upon them. This is uncomfortable for leading companies but good for society as a whole because it means that new ideas quickly spread throughout the entire economy.

Worryingly, a group of researchers at the OECD, Dan Andrews, Chiara Criscuolo, and Peter Gal, argue that good ideas are taking longer to diffuse than in the past. The top 5 percent of elite firms, dubbed “frontier firms,” stay ahead for much longer than in the past, increasing their productivity, while the remaining 95 percent of firms remain stagnant. The information? technology industry is producing a class of superfrontier firms: the productivity of the top 2 percent of IT companies has risen relative to that of other elite firms. At the same time, technological diffusion has stalled, in part because frontier firms can hire the most talented workers and cultivate relations with the best universities and consultancies.

So why is the country stagnating?

The most important reason is the growth of productivity?suppressing entitlements—the collection of social benefits (primarily Social Security, Medicare, and Medicaid) that Americans enjoy simply by right of being Americans. Aside from a jump following the Second World War, the rise of entitlements was relatively modest for the first thirty years after the introduction of Social Security in 1935. Then it took off: between 1965 and 2016, social benefits increased at an average rate of 9 percent a year. The share of GDP going to social benefits rose from 4.6 percent to 14.6 percent, a huge displacement.

The United States is now encrusted with entitlements. Fifty?five percent of all U.S. households receive cash or in?kind assistance from at least one major federal entitlement program. Almost all Americans over sixty?five receive Social Security and Medicare. Eighty percent of Americans living in households headed by single mothers receive entitlement benefits and 58 percent of American children live in families that are claiming entitlements. About 120 million Americans (two?thirds of recipients) claim benefits from two or more programs, and about 46 million (almost a third) claim from three or more programs.

This entitlement regime only bears a loose relationship to need: over 90 percent of social insurance assistance goes to a single demographic group that is defined by age rather than need—people aged sixty?five and over. The government distributes about fifty thousand dollars a year in Social Security and Medicare benefits to the typical married couple who retired at age sixty?six in 2016, just six thousand dollars less than the median income of U.S. households in general. Yet these retirees have lived through some of the most prosperous years in American history. They can also expect to live longer than any previous retirees. The burden of supporting this gilded generation will fall on current workers who have had far fewer opportunities than their seniors and have to simultaneously provide for their own children.

It is in the nature of entitlement spending that most of it is on automatic pilot: people are enrolled and payments rise according to fixed formulas. So entitlements rise at a fixed rate regardless of how the economy is performing or who is sitting in the White House. Presidents can talk about the virtue of small government as much as they like. The core entitlement programs will inevitably expand as the population ages, prices increase, and health?care costs rise. The three basic entitlement programs—Social Security, Medicare, and Medicaid—now make up almost 50 percent of the federal budget, and that number is slated to rise over the coming decades regardless of partisan political advantage.

Americans like to think that they have “earned” their entitlements: they are simply getting back what they put into the trust funds plus interest. They make a sharp distinction in their minds between taxpayer?funded “handouts” (which can be cut) and “getting back what they put in” (which is sacred). In one AARP advertisement, a retiree proclaims, “I earned my Medicare and Social Security.” This is in fact an illusion. Americans are collectively putting in less than they are getting out: making up the actuarial shortfall would require a permanent tax increase of a third or a permanent cut in benefits of a fourth. Absent such changes, the Social Security trust fund will run out of money by 2034 and the Medicare fund will run out of money by 2029. But “my money returned” is an exceedingly powerful illusion that makes reform almost impossible.

Victor Hugo once said that there is nothing more powerful in politics than an idea whose time has come. He was wrong: the most powerful thing in politics is a heavily subsidized benefit that the recipient believes they have fully paid for.

Much worse is to come: over the next twenty years the number of Americans aged sixty?five and over will increase by 30 million while the projected number of working?age Americans (eighteen to sixty? four) will increase by only 14 million. The combination of the sheer number of retirees with the legacy of decades of entitlement liberalization and expansion will create a fiscal challenge bigger than any that America has faced so far. Previous periods of high federal expenditure and debt increase have been driven largely by wars that have eventually come to an end and, as military outlays contracted, so did the debt. America is about to enter a period of high federal expenditure and debt driven by entitlements that stretch ahead, adamantine and inescapable, as far as the eye can see. Left unchecked, this means a future of growing indebtedness and repeated fiscal crises.

Another problem is the growth of regulation, which acts as a tax on entrepreneurs’ two most valuable resources, their time and their ability to try new things. In the 1950s, the Federal Register, which lists all new regulations, expanded at an average of 11,000 pages a year. In the first decade of the twenty?first century, it expanded by an average of 73,000 pages a year. Federal laws and regulations now extend to more than 100 million words. State and local regulations add another 2 billion. The Dodd?Frank bill was 2,319 pages long. The 2010 Affordable Care Act is 2,700 pages long and includes a twenty? eight?word definition of a “high school.” Medicare has 140,000 reimbursement categories, including twenty?one separate categories for “spacecraft accidents.” Added to this is the fact that the American tax code contains 3.4 million words. This means that the land of the free has actually become one of the world’s most regulated societies: in 2013, for example, it ranked twenty?seventh out of the OECD’s thirty? five members when it comes to product?market regulation.

America’s regulatory overload makes it harder for the country to live up to its image of itself as a society of problem solvers and innovators. It adds years to most infrastructure projects because officials have to jump through so many hoops (particularly, these days, environmental hoops). During the Great Depression, it took four years to build the Golden Gate Bridge. Today bigger highway projects take a decade just to clear the various bureaucratic hurdles before workers can actually get to work.

Overregulation forces business founders to endure a Kafkaesque nightmare of visiting different government departments and filling in endless convoluted forms. To open a restaurant in New York, for example, you need to deal with eleven different city agencies. It costs Americans a huge amount of time or money: half of Americans hire professionals to do their taxes compared with a minuscule number of Britons. It even turns children trying to make money for charity into criminals. In 2011, county officials closed down a children’s lemonade stand near the U.S. Open golf championship in Bethesda, Maryland, because the children, who were trying to raise money for pediatric cancer, didn’t have a vendor’s license.

Even if overregulation provides big companies with short?term advantages, it handicaps them in the longer term, making them more bureaucratic and less innovative. Established companies expand the size of departments that deal with compliance rather than innovation. They employ senior managers who invest their time in schmoozing politicians and wooing bureaucrats rather than improving their products. The biggest cost of regulation is that it leads to the bureaucratization of capitalism—and thereby kills the spirit of entrepreneurial innovation.

Alan Greenspan and Adrian Wooldridge are the authors of Capitalism in America: A History, from which this article is excerpted.