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The Slowing Pace of 'Creative Destruction' in Canada

By David Williams

“The fundamental impulse that sets and keeps the capitalist engine in motion comes from the new consumers’ goods, the new methods of production or transportation, the new markets, the new forms of industrial organization that capitalist enterprise creates”  
(Schumpeter 2003, 82-83). 

The beating heart of any market-based economy is “creative destruction,” a concept introduced in 1942 by social theorist Joseph Schumpeter. Creative destruction involves economic renewal or “churn,” whereby innovative new firms and entrepreneurs force outdated firms to exit. Labour and capital are freed and reallocated to better use, in doing so raising productivity and living standards. Canadian data is concerning because it suggests a significant, long-term decline in the rate of economic renewal. 

What Does the Canadian Data Show? 

Recent studies by the Bank of Canada highlight two key trends.[1] First, the rate of firm turnover has declined. The “entry rate” – the proportion of new firms among total active firms – has halved from 24% in 1984 to around 12% in 2016 (Figure 1). Meanwhile, the “exit rate” – the proportion of exiting firms among total active firms – has declined from around 17% in 1984 to 11% in 2016.[2] 

Figure 1:  Firm Turnover in Canada Has Declined Over Time

          Source:  Leduc (2017).

The entry rate declined sharply across the 1980s to the early-1990s, and again in the late-1990s. The exit rate followed a similar downward path except around the late-1980s and early-1990s, and around the 2009 recession, as difficult economic conditions saw a higher proportion of firms exit (Cao et. al 2017). The decline in firm turnover is broad-based across most major industries except the resources sector (Figure 2).[3] It therefore cannot be attributed to changes in the industrial composition of the economy: the decline in firm turnover has happened within sectors and is thus a feature of the economy as a whole.

 Figure 2:  Firm Entry and Exit Rates Have Declined Across Most Sectors
(1984 to 2012, % change)

          Source:  Cao et. al. (2017).

The second trend is that new entrepreneurship – defined as the proportion of self-employed workers (whose job tenure is less than 13 months) among the working-age population – has also declined.[4] The decline is most pronounced among prime-age workers between 25-34 years and 35-44 years (Figure 3), among university graduates (Figure 4), and among men (Figure 5). Dwindling rates of new entrepreneurship are evident in all regions -- and especially in BC (Figure 6).[5] 

Figure 3:  The Decline in New Entrepreneurship is Most Pronounced
Among Prime-Age Workers...

 

            Source:  Cao et. al. (2017).

 

Figure 4:  ...Among University Graduates...

 

          Source:  Cao et. al. (2017).

 

Figure 5:  ...And Among Men

 

          Source:  Cao et. al. (2017).

 

Figure 6:  New Entrepreneurship Rates Have Declined Across All Regions,
Especially in BC

 

          Source:  Leduc (2017).

 

Searching for Answers 

What is driving these trends? Canada is not alone among OECD countries in seeing a sustained fall in firm turnover and new entrepreneurship.[6] So at least part of the Canadian experience could be due to factors that are common across many of the advanced economies (Leduc 2017).[7] 

Some of the more promising explanations are that would-be entrepreneurs, particularly university graduates, have more attractive and flexible paid-employment options than in the past. In other words, the opportunity costs of entrepreneurship are higher, especially for individuals with high levels of educational attainment. Second, entrants may face higher barriers to entry than in the past due to shifts in technology. Some of today’s incumbent firms possess vast network advantages and economies of scale that are more formidable entry deterrents than in the past.[8] Finally, entrants may face greater difficulty in obtaining finance for the intangible investments that are central to modern businesses (Leduc 2017). Providers of finance may find an entrant’s organizational capital – intellectual property assets such as patents, copyrights, goodwill and trademarks, human capital, processes and technologies – difficult to value.  In such situations, a new firm may have difficulty obtaining credit. 

The answer as to what is driving these trends is far from settled.  Nevertheless, it is an important question because a less dynamic economy implies slower growth in living standards – something that deserves attention in Canada.  The issue is especially relevant in BC, given this province’s dependence on small businesses and start-up firms to help drive economic activity. 

References 

Autor, D., Dorn, D., Katz, L. Patterson, C. and J. Van Reenen. 2017. “The Fall of the Labor Share and the Rise of Superstar Firms.” National Bureau of Economic Research, NBER Working Paper No. 23396. 

Cao, S., Salameh, M., Seki, M. and P. St-Amant. 2017. “Trends in new firm entry and new entrepreneurship in Canada.” Canadian Public Policy, 43(3), 202-220. 

Davis, S. and J. Haltiwanger. 2014. “Labor Market Fluidity and Economic Performance.” National Bureau of Economic Research, NBER Working Paper No. 20479. 

Finlayson, J. and K. Peacock. 2017. “From Good to Great: The Benefits of Scaling Up BC Businesses.” Business Council of British Columbia. Publication prepared for the BC Business Summit 2017. 

Leduc, S. 2017. “Seeking Gazelles in Polar Bear Country.” Speech to the Sherbrooke Chamber of Commerce, October 3. 

Schumpeter, J. 2003. Capitalism, Socialism, and Democracy. Taylor and Francis e-Library (original publication 1942).

 


 

[1] These studies are Cao et. al (2017) and Leduc (2017).

[2] Firm entry and exit rates are based on the Statistics Canada’s Longitudinal Employment Analysis Program (LEAP) as analyzed by Cao et al. (2017) and updated in Leduc (2017).

[3] The absence of a decline in firm turnover in the mining, quarrying, oil and gas sector is likely due to the positive impact of the post-2000 global commodities boom (Cao et. al 2017).

[4] Entrepreneurship rates are based on Statistics Canada’s Labour Force Survey as analyzed by Cao et. al 2017.

[5] Even so, BC has the highest proportion of small businesses among the provinces. There were 83.4 small businesses per 1,000 population compared to 69.9 for Canada in 2017. The issue, however, is that these firms tend to stay small and domestically-orientated. See Finlayson and Peacock (2017).

[6] See Davis and Haltiwanger (2014), for example.

[7] Canada’s productivity levels relative to peer nations have declined over time, so common factors are unlikely to provide a complete explanation.

[8] US evidence shows that market share has become more concentrated across many industries since the early 1980s (Autor et. al 2017). Sales are increasingly dominated by “superstar” firms featuring high profits and a low share of labour in firm value-added and sales. The finding is based on an analysis of micro-panel data from the US Economic Census since 1982.