Business Dynamics and Macroeconomics

Is new firm formation "constant"? I'm betting it isn't, and that it's quite low at the moment, due at least to a perception of political risk of various sorts (cap&trade, unknown healthcare expenses, taxes going up, card check, etc).

My wife has been selling small businesses for about ten years, and this year has been truly awful as there's simply no buyers, even with lots of businesses available for a song and nearly all sellers willing to arrange seller financing. The plural of anecdote is not data, but I'm not seeing a lot of people eager to go out and start businesses right now.

This idea isn't especially new. Marc Melitz, back in 2007 I believe, wrote up an RBC model that incorporated endogenous entry of producers. Due to the assumption of sunk cost investment he is able to get a model where entry is very sluggish during recessions and is a powerful mechanism for propogating the business cycle movement. The theory has a lot of appealing empirical features to it as well so there is potential there for further development. Adding in nominal frictions would probably only improve his result.

I further suspect if you extended his model to incorporate credit frictions and time-varying risk aversion by creditors it would amplify his results even further. A policy implication of his model would be to make the sunk entry cost of investment lower to encourage greater entry. Possibly through investment tax credits?

Of course, monetary policy would be the most powerful tool to use, but since the Fed is just going to sit around an investment tax credit wouldn't be a bad idea (is it ever a bad idea anyway ...).

New firm formation has been down, in part as a result of SarbOx. This financial reform bill should put the final nail in the coffin.

@Ted:
'A policy implication of his model would be to make the sunk entry cost of investment lower to encourage greater entry. Possibly through investment tax credits?'

That is somewhat gamable. I would rather just lower the barriers to entry by making it easier to:
1. form new firms
2. have IPOs
3. get VC and angel funding

Unfortunately, the financial regulatory overhaul goes in the opposite direction on all three of these.

Of course the reason for large firms not losing (or adding) many new people is because of bureaucratization. That creates job protection around workers. More damage can be absorbed, of course -- but at the expense of innovation and strong growth.

@Doc Merlin

I generally try to think of ideas that would at least have a marginal chance of passing in congress, but I agree those would be superior reforms. But barrier reduction is hardily a platform a politician wants to run on, and they always like to brag about tax cuts so investment tax credits are more likely to succeed.

Can't we assume, just on the basis of reduced access to credit, that fewer firms will be created? Doesn't venture capital dry up in times of uncertain expectations?

I would guess, at the margin, by comparison to non-recession years, a) - d) are all true.

@N:
"Can't we assume, just on the basis of reduced access to credit, that fewer firms will be created? Doesn't venture capital dry up in times of uncertain expectations?"

There is tons of VC money out there, but a lot of the new laws make access to it much more difficult.