Drunks, A Wall, Entrepreneurs and Jobs

That young firms account for most of the job creation in the U.S. – as written about my Kauffman colleagues Dane Stangler, Bob Litan, and others -- has quickly become one of those compelling facts that changes the way you apprehend the entrepreneurial world. Young firms assume their rightful priority of place, and the vexing conflation of young/growth firms with small firms is finally and rightly undone.

I am going to take a different perspective on the relation between young firms and job creation, however. I want to explain its mathematical inevitability, and I’m going to do that using the probabilistic idea of the drunkard’s walk.

It works like this: Imagine an inebriated bar-goer having exited the bar, and now standing outside along the wall. Imagine further that in his or her state every single step is random, a coin flip whether it will be toward or away from the bar wall.

At first, however, the bar-goer is at the wall, so further steps toward the wall can’t happen. The only direction he or she can go with that first step is toward the curb. After that things change, of course, with at least some steps toward the wall possible, after which the drunkard is back at the wall and unable to go further. Given enough time, and with 100% probability, the drunkard will eventually end up in the gutter away from the wall.

Evolutionary theorist Stephen Jay Gould famously used the idea of the drunkard’s walk to explain the rise of complexity over time in humans. It wasn’t progress, he argued, just a blind evolutionary process staggering away from a left wall of minimum biological complexity.

The same holds in job creation. Young companies are the single-celled paramecia of the economic world: at t=0 they stand at the bar wall facing the gutter. They can’t lose jobs because they haven’t created any yet. All they can do initially, other than fail, is stagger away from the zero employment wall. Now, we know that about half of young companies last five years, more than enough time for companies to stagger back and forth such that, even if we assume no managerial skill, the drunkard’s walk model tells us they will grow and add jobs, even if only because that left bar wall prevents them from going below zero jobs.

The same doesn’t hold for older companies. They have been in business long enough that at t=0 they are already some distance from the bar wall, staggering back and forth. They can create jobs, of course, but they can also lose many jobs, the latter being something young companies mathematically cannot do given how they start at the left wall of zero employment.

In short, the central thing about job creation from young companies is its inevitability. It is a species of mathematical certainty (one driven by initial simplicity and a wall) that young companies must create the most jobs (even without assuming particular skill on their part, or taking into account sectoral or economic growth, both crazily conservative assumptions). That the drunkard’s walk applies to the economics of young firms is an mind-altering realization (in a good way), one that helps put the messy data of company and job creation in a more plain and meaningful context.

Comments

[Elliot Cohen]

Paul,

While i completely agree with your conclusions (being an entrepreneur in a small firm myself), there is an assumption missing that (it seems to me) changes the basic dynamics.

Small firms are not statistically independent of large firms.

Therefore, if (as a society) we spend all of our resources focusing on small firms, we are changing the large firm dynamic in at least a couple of ways:
1. Some of the best agents of a large firm are not working for a small firm.
2. The small firm could grow but take so much market share from the large firm that the large firm loses more jobs than the small firm adds.
3. Small firms are by definition less capital rich than large firms and thus they generally need greater efficiency which can speed the process of using foreign labor or technology to replace local human resources.

That said, large firms are by your argument rightfully less likely to create change and growth and therefore small firms clearly need to be encouraged, but i thought it was an interesting point to add to this discussion.

Thanks for the post, i really enjoyed it.

-E

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[Dave]

So... by your logic, should all firms be dissolved after a certain period of time, so that it is mathematically impossible for jobs to be "lost?" That seems to be the logical conclusion of this post.

If job creation is what is important (instead of actual production), then it follows that we should prioritize job creation. If young firms are better at job creation, then we should get rid of the inefficient old firms and replace them with young firms.

But this, of course, is something you are likely to disagree with and rightfully so. Job creation cannot be what is important; it MUST be production. Therefore, focusing on job creation is actually bad for an economy. Further, jobs are actually an economic bad and it is the entrepreneur's duty to destroy them whenever possible, not to create them. For more on this, see Schumpeter's book, "Capitalism, Socialism, and Democracy."

[Asp]

The same goes for fast-growing emerging economies, I guess.

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