Business dynamism occurs when new firms enter the market, existing firms expand, and less productive firms exit. But business dynamism is fading in many economies around the world, disrupting the process by which resources, such as labor and capital, are allocated efficiently in the economy.
Much of the evidence for this can be seen in advanced economies, like that of the United States. But it is also happening in less developed regions as well, and is accompanied by other negative and related trends, such as slower productivity growth, rising market concentration and widening labor productivity gaps between companies.
The question that policymakers now face is what potential measures can arrest this decline — with actions ranging potentially from those that stimulate knowledge sharing among businesses to anti-trust measures.
The Nature of Business Dynamism
Business dynamism helps drive global productivity growth. It allows resources to flow from less productive firms, which can be forced to exit the market, to more efficient, innovative ones. Dynamic markets foster innovation, efficiency, and economic resilience. Markets lacking dynamism risk stagnation, as declining firm entry and competition lead to reduced innovation and slower productivity gains.
The decline in business dynamism globally over the last two to three decades is well-documented, with a range of measures used to capture this trend. In the U.S., studies reveal a marked reduction in firm entry and job reallocation rates, and in firm growth dispersion (the difference of growth rates across firms). Similar patterns have been observed in Europe, with decreasing business dynamism contributing to slower productivity growth. This decline in dynamism, combined with increasing market concentration, suggests that economies are becoming less adaptable. Fewer new firms are challenging incumbents. As a result, there is less competition, leading to potentially slower growth in the long term.
A similar pattern can be seen in Latin American countries. Figure 1, using data from the OECD DynEmp project, reveals different job reallocation and firm entry rates. Both Brazil and Costa Rica (in blue) are in the negative quadrant, with reductions in job reallocation and entry rates over the period 2000-2015, revealing overall how economies with larger slowdowns in job reallocation rates also have larger declines in the entry rates of firms.
Figure 1 – Variation in Job Reallocation and Entry Rates
Causes of the Decline
Many researchers point to the growing market power of large firms as a key driver of the drop in business dynamism. Too much market power has led to less competitive markets, higher barriers to entry, reduced job reallocation, and greater price markups.
Demographic shifts, particularly less growth in the labor force, have also been highlighted as a major factor. As populations grow more slowly, fewer firms enter the market, leading to a concentration of economic activity in larger, older firms. This, apart from increased market concentration, has led to larger average firm size, and a declining labor share of GDP. According to data from the OECD DynEmp project, demographic changes can explain the differences in firm entry rates across countries (Figure 2). But they do not explain very well the variation in entry rates over time (Figure 3), with other explanations possible.
Figure 2 – Firm Entry and Demographics
Figure 3 – Variation in Working Age Population Growth and Entry Rates
Technological advancements and globalization also have a significant influence. Technologies like software and data-driven processes have enabled larger firms to scale more efficiently, reducing the role of smaller competitors. While globalization initially spurred competition, it has allowed larger firms to expand across markets more easily, crowding out smaller ones. Meanwhile, the declining spread of knowledge, due in part to weakened antitrust enforcement and strategic patenting by large firms, has slowed innovation.
Tackling the Problem
Amid these challenges, policymakers may have to take a multifaceted approach. Robust anti-trust enforcement is critical to preventing monopolistic practices. Equally important are any other regulations that prevent large firms from stifling competition and that promote the market entry of smaller firms.
Many existing regulations, such as occupational licensing and non-compete clauses, are counterproductive, impeding new firm entry and limiting new ideas and products. And many tax laws are inefficient and deter growth. Policymakers should seek reform in these areas as well.
Finally, policymakers could support initiatives that facilitate knowledge sharing among firms, including partnerships between large corporations and startups, and the creation of platforms that enable smaller firms to access valuable data and resources. Initiatives that provide access to funding and mentorship programs for startups and small businesses would similarly help foster innovation and entrepreneurship. All these are but steps to address a highly complex problem. But the widespread decline in business dynamism threatens to have major implications for the economic trajectory of many regions of the world, and policymakers need to be aware of it and try to arrest it in the interests of greater fairness, innovation, and productivity growth.
