A few years ago I wrote about innovation and entrepreneurship in Norway and Qatar.  Both countries had grown incredibly wealthy off the back of oil and gas, and both were trying to diversify their economies for the day when the oil would run out.

A challenge faced by both countries was that the oil and gas sector continued to dominate both nation’s economies, and therefore well-paid jobs were readily available for talented people.  This ready supply of stable income made the inherent uncertainty of entrepreneurship a difficult sell.

Better alternatives

It’s a situation chronicled in a recent paper from Wharton, which highlights how in recent years high-skilled graduates have discovered that they can earn more in salaried jobs than they could by starting their own business.

The situation has been compounded by the prolonged cheap capital that has allowed businesses not only to be profitable but also to expand their workforces with highly skilled talent.  Indeed, the author argues that this alone is responsible for about 75% of the decline seen in entrepreneurship in the United States.

They believe that their findings add additional nuance to the current narrative that suggests that the decline in entrepreneurship is largely a consequence of higher startup costs, labor constraints, or even the aging population.  A recent report from the Congressional Budget Office is a good case in point, with the blame placed on access to finance and regulatory hurdles.

Opportunity costs

The study found that the share of entrepreneurs fell by around half between 1985 and 2014, with just 4% of households containing an entrepreneur by the end of the study period.  This decline was especially pronounced among college graduates, with the fall among this group seeing the 12% of households containing entrepreneurs in 1985 become just 5% by 2014.

It also emerged that the share of households that start a new business had declined significantly over the last 30 years, with those entrepreneurs who did create a business typically being much more highly skilled than at any time in the past.

The author believes that while lower costs of capital would certainly help raise the entrepreneurship rate, it would be most beneficial to entrepreneurs with lower skills.  This would have less of an impact on higher-skilled entrepreneurs, for whom the decline has been most pronounced.

“The increase in the share of entrepreneurs with lower skills is not as fast or not as strong to overcome the decline among those with higher skills,” the researcher explains.

High-skilled entrepreneurs

This decline in highly-skilled entrepreneurs was also discovered by a study from Osaka University, which shows that the rate of startup formation has been on the decline for companies run by PhDs in science and engineering since 1997, which is particularly worrying as this group is regarded as crucial in transferring knowledge from lab to market.

“We link this to an increasing burden of knowledge by documenting a long-term earnings decline by founders, especially less experienced founders, greater work complexity in R&D, and more administrative work,” the researchers explain. “The results suggest that established firms are better positioned to cope with the increasing burden of knowledge, in particular through the design of knowledge hierarchies, explaining why new firm entry has declined for high-tech, high-opportunity startups.”

They argue that it is not so much the higher pay offered by established businesses that is the problem but the burden of knowledge required in science-driven fields today.

They argue that, for instance, in medicine, the doubling of medical knowledge in 1950 took 50 years, in 1980 this had shrunk to 7 years, and by 2010 it was down to just 3.5 years. Indeed, what students learn in medical school will be just 6% of what they know within a decade of practicing.

“We argue and find that an increasing burden of knowledge also leads to fewer high-tech high-opportunity startups,” the researchers explain. “We argue and find that it also leads PhDs to amass greater work experience before becoming a founder, to shoulder more R&D tasks as founders, and not being rewarded for that extra work.”

This subsequently makes working for established firms a more attractive option as by the time scientists and engineers are ready to create a startup they already have established a career for themselves. This underlines the decline in entrepreneurship in medicine, for instance, with just 31.4% of physicians operating as independent owners in 2019, versus 48.5% in 2012.

Positive or negative?

Perhaps instinctively this decline in entrepreneurship is viewed as a negative phenomenon.  After all, our economy thrives on innovation, so if new businesses aren’t being created, that innovation is not as healthy as it might otherwise be.

Indeed, it’s not uncommon for policymakers to propose various interventions to arrest this decline.  It’s not a pessimism shared by the Wharton academic himself.

“The concern should not be about the share of entrepreneurs,” he says. “Instead, you may want to ask how to make existing entrepreneurs more productive.”

The paper suggests that many of the entrepreneurs that are being put off are not those who will go on to create a groundbreaking new company.  The author argues that those people will find a way to succeed despite all of the obstacles in front of them.  Instead, the entrepreneurs being lost to gainful employment are those who would otherwise flit between the two worlds.

This has been evidenced during a pandemic that has seen entrepreneurship bounce back.  It’s a trend that has largely seen a rise in more low-skilled entrepreneurship, and as such, the Wharton theory would suggest that these entrepreneurs will have a negligible long-term impact on the economy.  While unemployment spiked in the early months of the pandemic, there has also been a corresponding rise in wages as organizations attempt to lure talent back.  Whether that will see a slump in entrepreneurship as people are tempted back into salaried work, time will tell.