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05 november 2021 Algemeen
Olaf Sleijpen

On 5 November, Olaf Sleijpen opened the 24th Annual Research Conference of De Nederlandsche Bank. This year’s conference theme was: “The Economy in Transition: Efficient and Sustainable Policies to Support Business Dynamism”. In his opening address, Olaf Sleijpen acknowledged the importance of business dynamism. “This process makes the blood pump through our economies’ veins,” he said. He further reflected on the essence of business dynamism, which is room for failure without letting it be the end of entrepreneurship. When economies and societies look at failing as an opportunity to learn, to improve, to come up with something new, they will thrive. And with major tasks ahead of us, he concluded that “we simply need strong business dynamism. We need innovative start-ups to tackle the risks of climate change. We need room for failure on the business level in order not to fail on an aggregate level – in order not to fail at safeguarding our societies.”

Date: 5 november 2021
Speaker: Olaf Sleijpen
Location: Amsterdam (digitally)

Hello everyone.

Welcome to the 24th Annual Research Conference of De Nederlandsche Bank. Unfortunately, the second time in a row virtually.

As a central bank, we need to inspire trust and stability. We cannot afford to make mistakes. Ever.

Or can we? Because there is a lot to learn from mistakes.

We discovered, for instance, that the idea that we are not allowed to fail is actually quite an issue in our organisational culture. Because the idea of having no room for failure, might actually mean that we are missing out on opportunities to learn. To improve. To come up with something new.

Now, why am I telling you this when I am supposed to be talking about business dynamism?

Well, I am telling you this because failing is an essential part of business. In a nutshell, business dynamism is the process of new firms starting up, growing, shrinking, and failing. Over and over again. And this process, with all its aspects, is paramount for economic growth. This process of creative destruction leads to innovation, more wealth and more jobs. This process makes the blood pump through our economies’ veins.

As a supervisor, we are in favour of financial institutions learning from their mistakes, but, of course, not to the extent that these mistakes lead to a financial stability risk. But even then the question is justified whether regulators and supervisors do not err too much on the cautious side, overweighing the externalities of financial institutions going bankrupt.

So how are our economies doing with respect to business dynamism? With respect to start-ups?

Let’s first look at a few numbers.

Recent research has shown that, in general and on both sides of the Atlantic, there is a clear decline in the start-up rate.

From around the year 2000, the US economy saw a significant decline in young high-growth firms.[1] These type of firms are characterised by two features: they have experienced an annualised growth rate greater than 20 percent for three years; and at the start of their growth period, they had at least ten employees.

A similar pattern characterizes European countries. The Dutch economy, for instance, has relatively weak business dynamism. Particularly, in sectors like services and manufacturing. In those sectors we see an average post-entry growth and survival share of market entrants below that of the OECD benchmark countries.[2]

Moreover, employment in the Netherlands is more concentrated in firms with more than 50 employees than in our peer countries, like the Scandinavian countries, Italy and Spain. This means that young high-growth firms do not account for as much of the Dutch economy as in our peer countries.

What underpins these patterns, at least for the US, is that the decline in the start-up rate is accompanied by a relatively stable firm exit rate. Taken together, this means that the number of firms is declining. And this may lead to weaker competition.

And this is concerning. Why?

Because we need strong business dynamism. The figures show that young firms are engines of growth. They account for a disproportionately large fraction of aggregate job creation.[3] And a fast pace of market entry and exit is associated with creative destruction.[4] And that kind of destruction typically prompts innovation.

Across OECD countries, on average and over the years, young firms – that is firms that are younger than 5 years – account for about 20 percent of total employment. But – they create almost half of all new jobs.

Let’s look, for instance, at transformational entrepreneurs’ start-ups. These are start-ups that create innovative solutions to the world’s biggest problems, like climate change. Solutions that are scalable, sustainable and systematic. When we look at these transformational start-ups in the Netherlands, we see that they create slightly over 20 percent of new jobs. In France, that number rises even to more than 50 percent.[5]

With these numbers in mind, I think you can rightfully say that declining business dynamism, and with it a diminishing number of young high-growth firms, is indeed concerning.

The situation is made worse by the fact that incumbent firms do not take up the slack left by exiting firms. Research finds that, once we take firms’ life-cycles into account, incumbent firms have not changed their behaviour over the past three decades.[6] In other words, the lack of job creation from fast growing start-ups has not been offset by higher job creation by incumbent firms. This has the potential to affect aggregate job creation, and thus employment, in the long run.

I think our policy makers should be aware of these trends and make sure that a further decline in business dynamism is avoided. Of course, policy makers have other concerns too.

According to the IMF, the Financial Stability Board, and others, climate change is a major threat to our economies, our financial systems, and our prosperity.

One major task lying ahead of us, is the transition to a low carbon economy. So one question for this year’s conference is: how can policy makers design policies for the transition to a low carbon economy, without further harming business dynamism?

This is all the more pressing as the necessary energy transition hinges on successful technological innovations. Let me quote from a recent statement by the International Energy Agency: “most of the global reductions in CO2 emissions between now and 2030 in the net zero pathway come from technologies readily available today. But in 2050, almost half the reductions come from technologies that are currently only at the demonstration or prototype phase.”[7]

Early on, these innovative technologies are often less competitive than fossil alternatives. Banks are therefore more hesitant to finance these higher risk activities. And innovative start-ups are often too small to attract capital market financing.

So currently, innovation investment is best aligned with the risk appetite of private equity firms. But they do not have a large presence around the world.

So this is where governments come in.

The bulk of the much needed investments will indeed have to come from the private sector – but there is a loud and clear sine qua non. And that is that governments create investment conditions that improve the business case for climate investments.

Indeed, research confirms that regulation plays a significant role in the start-up rate.[8] The long-run number of firms is found to be proportional to the average entry cost. So if regulation leads to higher entry costs for new firms, the total number of firms will decline, and the average firm size will increase – which could harm competition, and have negative spill-over effects to the economy in general.

Regulation can, of course, also lead to a more favourable business environment. That is, for instance, why we advocate a clear, consistent and stable climate policy. Reducing regulation uncertainty could lower the risk for investors in new technologies, and promote investment.

So in designing climate policies, the effects on business dynamism need to be taken into account.

The pandemic made the task of policy makers and the research community even more challenging. Later today, we will learn more about the effect of the pandemic on business creation. Business application data in the US suggest that this effect was asymmetrical among sectors and countries.[9]

With unprecedented policy measures, our governments aimed to protect viable and productive firms. They aimed to avoid a wave of bankruptcies, and all the risks that would entail. And these measures likely alleviated the adverse economic effects of the pandemic. But they might also have done so at the risk of keeping so-called “zombie firms” afloat. And this would, of course, interfere with the valuable process of business dynamism that I described before.

So we have a number of key questions to address today. And discussing these pressing questions in the setting of a central bank, is right up our street.

One of the roles of central banks, like De Nederlandsche Bank, is to provide independent, high quality economic research, in conjunction with our tasks in the area of monetary policy, financial stability and prudential supervision. Central banks can deliver the facts. They can point to risks for the financial sector and the economy. And they naturally have a long run view. That makes central banks ideally placed to assess, for instance, climate-related policy options, whose full impact may only become apparent in decades. They can show which policies are effective and which are not.

Let me wrap up.

I have learned over the years, that failing in itself is not always a bad thing. It all depends on how we deal with it. If we let failure be the end of someone exploring their ambitions, of someone’s entrepreneurial spirit, we are doing something wrong. If we succeed in looking at failure as a learning opportunity – however painful the experience for everyone involved might be – our economies will thrive on this business dynamism, and our societies will only prosper.

Moreover, we simply need strong business dynamism. We need innovative start-ups to tackle the risks of climate change. We need room for failure on the business level in order not to fail on an aggregate level – in order not to fail at safeguarding our societies.

Thank you. And I wish you an inspiring day.

 

[1] Decker, Ryan A., John Haltiwanger, Ron S. Jarmin, and Javier Miranda. 2016. "Declining Business Dynamism: What We Know and the Way Forward." American Economic Review, 106 (5): 203-07.

[2] OECD (2021), “Netherlands: Business Dynamics”, OECD Insights on Productivity and Business Dynamics, March 2021.

[3] Haltiwanger, John, Ron S. Jarmin, and Javier Miranda. 2013. “Who Creates Jobs? Small versus Large versus Young.” The Review of Economics and Statistics, 95 (2): 347–61.

[4] Lucia Foster, John Haltiwanger, and C. J Krizan. 2006. “Market Selection, Reallocation, and Restructuring in the U.S. Retail Trade Sector in the 1990s.” The Review of Economics and Statistics, 88 (4): 748–758.

[5] OECD (2016), “No Country for Young Firms?”, Policy Note, Directorate for Science, Technology and Innovation Policy Note, June 2016.

[6] Pugsley, Benjamin Wild, and Ayșegül Șahin. 2019. "Grown-up business cycles." The Review of Financial Studies, 32.3: 1102-1147.

[7] International Energy Agency 2021, accessed 29 October 2021, Pathway to critical and formidable goal of net-zero emissions by 2050 is narrow but brings huge benefits, according to IEA special report - News - IEA

[8] Gutiérrez, Germán, and Thomas Philippon. 2020. “Some facts about dominant firms.” National Bureau of Economic Research, No. w27985.

[9] Ascari, Guido, Andrea Colciago, and Riccardo Silvestrini. 2021. "Business Dynamism, Sectoral Reallocation and Productivity in a Pandemic." DNB Working Paper No. 725.