The Great Hollowing Out Of The Middle Class: New Business Formation Collapses

For a country that prides itself (or used to at least) on the success of the entrepreneur and small business creation, a disturbing trend has developed. According to according to a new analysis by the Economic Innovation Group, fewer new businesses were created in the last five years than any other period since at least 1980.


"It's hard to put into scale the collapse of new business formation. We have no precedent for that rapid and steep of a decline. It will have a ripple effect in the economy. You're going to feel that impact five, 10, 15 years in the future" said John Lettieri, co-author of the report and co-founder of EIG.


Businesses that did form during the last five years are far more concentrated than ever before, with just 20 counties accounting for half of the country's total new businesses, all of them in large metro areas around large cities such as Los Angeles, Miami, Chicago, Dallas, New York, and San Francisco Quartz reports.


As large metro areas saw new business formation, sparsely populated areas were hardest hit. What's also important to note, is that the new businesses are more tech oriented and less of the traditional construction firms and restaurants that have helped the middle class in prior years. A shift that has been driven primarily by entrepreneur access to capital.

From Quartz

Particularly hard hit were sparsely populated, rural areas. In the last post-recession recovery, counties with 100,000 or fewer people generated one-third of the country’s new firms (net) between 1992-96. By comparison, those counties lost 1.2% of their businesses between 2010-2014.


The second story is that the majority of new companies look more like tech companies than the construction firms and restaurants that have typically anchored middle-class prosperity. New business formation over the past five years tracked very closely with access to capital, particularly venture and other forms of risk capital, says the report. Of the top 20 counties, 13 were in just three states (California, New York, and Texas) with ample access to such money. That shift has given highly educated urban dwellers another advantage at the expense of everyone else, a disparity polls suggest is fueling the rise of Republican presidential candidate Donald Trump among working-class, rural Americans.

The decline in opportunity for rural Americans was set in motion by the financial crisis, which saw the number of independent commercial banks drop by 14 percent between 2007 and 2013. The collapse in housing prices only accelerated the issue, as the opporunity for entrepreneurs to draw home equity loans was wiped out as prices fell.

This great hollowing out of opportunity for rural and non-urban Americans was set in motion and then accelerated by the financial crisis. First, the 2007-2008 crisis gutted the financial sector, even among banks untouched by subprime-mortgage fraud. The number of independent commercial banks dropped by 14% between 2007 through 2013, according to the Federal Reserve (pdf), and the number of people with access to community banks (which traditionally loan to small businesses) plunged by 40%, says EIG. (Some of that reduction may have been mitigated by expansion of larger banks.)


Making this worse, the collapse in housing prices also exhausted one of the only sources of cash for would-be entrepreneurs: equity in their homes. As whole communities saw their savings evaporate, there was little to stave off a downward spiral amid layoffs and stagnation. “Personal wealth is a key ingredient for startups, and there’s not much wealth in these areas,” wrote Narayana Kocherlakota, head of the Federal Reserve Bank of Minneapolis, on Twitter about the report.

As a result, polls suggest that this trend of highly educated urban residents having advantages over everyone else is fueling the rise of Donald Trump in his bid for the White House. Economically, employment options are becoming depressed for those Americans who live in more rural areas of the US due to "a missing generation of firms" as John Lettieri calls it, which could prove to have significant consequences down the road in the form of unemployment benefits and a drop in consumer spending.

"Trends are pushing us faster in this direction as capital and knowledge-based economic activity are attracted to large, connected cities. Half-measures and policy tweaks may not be enough to stem this. It's only recently that we're starting to fully understand the challenge that new companies are facing. You need proactive and coordinated effort to start reversing that trend. It won't reverse on its own." Lettieri said.

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One could argue that it was the intent of the Federal Reserve to eliminate competition for its members from the beginning, something that the latest financial crisis (created by the central bank) seems to have helped out with tremendously. Sadly, middle class Americans are paying the price for that.