The Decline of the Middle Class and Call for Innovation
Our Current Socioeconomic Landscape and What the Future Holds
From recent media coverage, you might think we're living in the Age of the Startup. Disruptive entrepreneurialism and Silicon Valley startup culture are the major business trends of the 21st century, and nearly all Americans have had their lives affected, if not transformed, by the resulting innovative technology. But startups are more than hip Silicon Valley tech firms trying to invent the next killer app. Across the economy, startups — of all sizes and in all industries — have been in decline for 30 years. The middle class has also been in decline over that period.
These two things are related.
Power is being centralized in huge businesses. Jobs are being lost to artificial intelligence and automation. Rapid technological improvement is accelerating these forces, leaving people with a shared feeling — of uncertainty.
New businesses and a thriving middle class are key ingredients of a strong job market. As we move toward the future, we need to understand the relationship between business creation, job growth, economic equality, innovation, and entrepreneurship.
The State of American Businesses
We're Witnessing a Disturbing Trend in the Decline of New U.S. Businesses.
The 2017 Kauffman Index of Startup Activity finds that "startup activity remains in a long-term decline when compared to activity levels in the 1980s." Citing Kauffman Foundation and U.S. Census Bureau data, Inc. editor Leigh Buchanan writes, "The number of companies less than a year old had declined as a share of all businesses by nearly 44 percent between 1978 and 2012."
In FiveThirtyEight, Ben Casselman notes that, according to the Census Bureau, "Americans started 27 percent fewer businesses in 2011 than they did five years earlier. … As a share of all companies, startups have been declining for more than 30 years."
Census Bureau data also suggests that "fast-growing startups [those that economists care most about due to their impact on increasing living standards or technological progress] are disappearing more quickly than slow-growing ones," Casselman notes. "In 1982, 75 percent of all 5-year-old firms had fewer than 10 employees, while 12 percent had 20 or more. Two decades later, the share of new companies that stayed small had risen to 80 percent, while only 8 percent grew to 20 or more employees."
In an article for the Atlantic, Jordan Weissmann makes an important point about terminology: "When most people hear the phrase 'start-up,' their minds immediately leap to small tech firms in Silicon Valley vying to become the next Facebook, Square, or Twitter. But those companies actually make up just a small, rarefied strata of new businesses — one which seems to be doing relatively fine." Weissmann goes on to say, "It’s when we look at the full array of new companies, including what most of us just think of as small businesses in industries like construction or retail, that the problem becomes evident."
This trend is visible across industries. According to a 2014 Brookings Institution report, the decline in business dynamism and entrepreneurship have not "been isolated to particular industrial sectors and firm sizes." Nor is this trend limited to a particular geography. Brookings Institution's Ian Hathaway and Robert E. Litan point out that "the decline in entrepreneurship and business dynamism has been nearly universal geographically the last three decades — reaching all fifty states and all but a few metropolitan areas."
The Declining Number of New Businesses Has Troubling Implications for the U.S. Economy and Labor Force.
Citing data from the United States Census Bureau's Business Dynamics Statistics database, FiveThirtyEight's Casselman writes, "New businesses are a key driver of job growth, responsible for more than 15 percent of new job creation despite accounting for just 2 percent of total employment."
The U.S. Bureau of Labor Statistics' Business Employment Dynamics data demonstrates that "the number of jobs created by establishments less than 1 year old has decreased from 4.1 million in 1994 … to 3 million in 2015. This trend combined with that of fewer new establishments overall indicates that the number of new jobs in each new establishment is declining."
"The underlying worry is churn," writes Inc.'s Leigh Buchanan. "In a dynamic economy, businesses are born, grow, and die; jobs are created and lost; and resources are reshuffled according to their best use. If there are fewer new companies and more aging ones, then labor and capital hang tight in old industries. The economy is not refreshed and growth slows."
"We are behind in starting new firms per capita, and this is our single most serious economic problem," writes Jim Clifton, chairman and CEO of Gallup. "I don't want to sound like a doomsayer," Clifton continues, "but when small and medium-sized businesses are dying faster than they're being born, so is free enterprise. And when free enterprise dies, America dies with it." Clifton cited U.S. Census Bureau statistics showing that 400,000 new businesses are born every year — but 470,000 die.
The problem goes beyond job creation. For years, the loss of workers' welfare from depressed business creation was somewhat offset by the higher wages that came from comparable jobs at bigger companies. For the first time in decades, according to a recent study, this wage premium has disappeared. "Almost all of the drop is that large firms are paying the same types of people less," Stanford economist Nicholas Bloom, one of the study's authors, told the Wall Street Journal. "It’s not that they're hiring worse employees, they just seem to be paying less of a bonus."
The responsibility for these trends can't fall solely on the Great Recession of 2007–09. Citing work from University of Maryland economist John Haltiwanger, the Atlantic's Weissmann writes that the recession actually interrupted "the gradual mellowing of our job market."
What does that "gradual mellowing" mean? A shrinking middle class — the very thing needed for a strong, growing economy.
The Declining Middle Class and Increasing Income Inequality
The United States Middle Class Is in Decline.
It started as a chart hidden in a World Bank working paper. Now it's become widely known as the "elephant chart" or "elephant graph." It tracks growth in real income from 1988 to 2008 across the global income spectrum. At first glance, it looks like great news for the middle class, and globally speaking, it is. But pay attention to that dip that forms the base of the elephant's trunk, around the 80th percentile.
That group that's experienced almost no income growth? That's where you'll find the American lower and middle classes, who are relatively rich when placed on a global scale. Clearly, households in the 75th to 85th percentile of income distribution — "basically poor people in rich countries," as Kaila Colbin describes them in NewCo Shift — have not done well. These people, according to the Economist, "seemed scarcely better off in 2008 than they had been 20 years before."
The chart's creator, Branko Milanovic, said in a PBS interview that it shows how the lower and middle classes in the United States and other rich countries, such as Japan and Germany, have struggled. He also pointed out another important point found at the far right edge of the chart: "The top 1 percent in the rich countries have done well."
The chart has its critics. The Economist points out, for example, that the people in any income bracket in 1988 and 2008 might not be the same people. The 75th to 80th percentiles were dominated by "better-off Latin Americans and Westerners of modest means" in 1988, but by 2008 they had been joined by rich Chinese. How any bracket fared may not reflect how individuals did.
But Milanovic and his co-author, Christoph Lakner, accounted for this problem in their research, and other charts that illustrate how each income group fared over the 20-year period were less dramatic, but, the Economist admits, "recognisably elephantine."
The Pew Research Center provides the bottom line: "After more than four decades of serving as the nation’s economic majority, the American middle class is now matched in number by those in the economic tiers above and below it." Further, "In 2014, the median income of these households was 4% less than in 2000."
But the problem goes beyond the shrinking of the middle class.
The Divide Between Upper-Income Families and Lower-Income Families Is Increasing.
A related phenomenon is the growing divide between the people on either end of the income and wealth spectra. It's not quite true that the rich are getting richer and the poor are getting poorer. But it is the case that the rich are getting a lot richer, and the poor are mostly staying where they are.
A central takeaway from a 2014 Organisation for Economic Co-operation and Development (OECD) working paper is that "In most OECD countries, the gap between rich and poor is at its highest level [in] 30 years." This inequality trend is not "peculiar to America, but the trend is most visible there," the Economist wrote in 2015. "This is partly because the gap between rich and poor is bigger than anywhere else in the rich world."
In 2014, entrepreneur and venture capitalist Nick Hanauer wrote a "memo" in Politico, To My Fellow Filthy Rich Americans: The Pitchforks Are Coming. "Inequality is at historically high levels and getting worse every day," he wrote. Using data from the Tax Foundation, Hanauer wrote, "In 1980, the top 1 percent controlled about 8 percent of U.S. national income. The bottom 50 percent shared about 18 percent. Today the top 1 percent share about 20 percent; the bottom 50 percent, just 12 percent."
The previously mentioned Pew Research Center findings illuminate the extent to which upper-income families are gathering an increasing share of wealth:
The nation’s aggregate household income has substantially shifted from middle-income to upper-income households, driven by the growing size of the upper-income tier. … Fully 49% of U.S. aggregate income went to upper-income households in 2014, up from 29% in 1970.
In 1983, "Upper-income families … had three times as much wealth as middle-income families," and "by 2013, they had seven times as much wealth as middle-income families."
NewCo Shift's Colbin puts it this way: "If you were rich to begin with, you've gotten richer — your income's gone up by more than 60%" from 1988 to 2008.
The Circumstances and Absence of Opportunities That Inequality Creates Are Both Reinforcing and Intergenerational.
According to a RAND Corporation assessment of income inequality and intergenerational transmission of income, "Inequality of income and inequality of opportunity are correlated across countries, and this correlation could be driven by a variety of factors. In particular, greater disparities in income translate into greater disparities in families' capacity to invest in their children’s human capital."
"Far more than in previous generations," the Economist reports, "clever, successful men marry clever, successful women." This "'assortative mating' increases inequality by 25% … since two-degree households typically enjoy two large incomes."
In the Atlantic, Alec Macgillis and ProPublica suggested in 2016 that in many heartland American towns, "The most painful comparison is not with supposedly ascendant minorities — it's with the fortunes of one's own parents or, by now, grandparents."
Similarly, a 2013 Pew Research Center study found that Americans have "somewhat conflicted views about the economic prospects for the next generation. When asked about the future prospects of 'children today,'" almost two out of three Americans "said that when today's kids grow up, they would be worse off financially than their parents." Additional Pew Research from 2016 shows that this is no idle fear: "In 2014, for the first time in more than 130 years, adults ages 18 to 34 were slightly more likely to be living in their parents' home than they were to be living with a spouse or partner in their own household."
Part of this trend away from moving out has to do with demographic changes, as young people have been marrying later and less often. But "trends in both employment status and wages have likely contributed to the growing share of young adults who are living in the home of their parent(s)," Pew Research Center notes.
Again, because of media coverage of Silicon Valley and the startup culture and the innovations that affected the lives of nearly all Americans in the last quarter century, it's a good bet that most people worrying about a limited financial future for the young aren't aware that startups have been in decline over that time. What people are worried about when they fear for their kids' financial future is the loss of existing jobs, in older industries. And they're not wrong to worry.
The Effects of Increased Automation and Artificial Intelligence
America's Labor Force Will Change Dramatically — and Most People Are Unprepared.
Research conducted by McKinsey & Company found that less than 5 percent of occupations "are candidates for full automation. However, almost every occupation has partial automation potential," and "about half of all the activities people are paid to do in the world's workforce could potentially be automated by adapting currently demonstrated technologies. That amounts to almost $15 trillion in wages."
"The activities most susceptible to automation,” the McKinsey report notes, "are physical ones in highly structured and predictable environments, as well as data collection and processing. In the United States, these activities make up 51 percent of activities in the economy, accounting for almost $2.7 trillion in wages."
In their study "The Future of Employment: How Susceptible Are Jobs to Computerization?," Oxford researchers Carl Benedikt Frey and Michael A. Osborne estimate that "around 47 percent of total U.S. employment is in the high risk category … i.e. jobs we expect could be automated relatively soon, perhaps over the next decade or two."
The jobs and industries that may be most affected, suggests Fast Company's Michael Grothaus, include insurance underwriters and claims representatives, bank tellers and representatives, financial analysts, construction workers, inventory managers and stockists, farmers, taxi drivers, manufacturing workers, journalists and actors.
It would be ideal if our educational system were preparing young people for this looming future in which the traditional ways of working will be so disrupted. But it's not.
Current Structures for Education and Training
Deficiencies in Education Start in Early Childhood and Continue Through All Ages.
Inequality is baked into American education from the first day of kindergarten.
According to the Economist, America’s "education system favors the well-off more than anywhere else in the rich world. Thanks to hyperlocal funding, America is one of only three advanced countries where the government spends more on schools in rich areas than in poor ones."
Higher education is also slanted in favor of those with higher income. The Economist reports that America's "university fees have risen 17 times as fast as median incomes since 1980 … and many universities offer 'legacy' preferences, favoring the children of alumni in admissions."
The Pew Research Center's analysis of government data shows that "those Americans without a college degree stand out as experiencing a substantial loss in economic status."
"On the day they start kindergarten, children from families of low socioeconomic status are already more than a year behind the children of college graduates in their grasp of both reading and math," writes Eduardo Porter in the New York Times, and "nine years later the achievement gap, on average, will have widened by somewhere from one-half to two-thirds."
This gap is compounded by lack of access to STEM education. A recent report by the U.S. Commerce Department's Economics and Statistics Administration illustrates that STEM occupations are growing at a faster pace than non-STEM ones. Yet the U.S. Department of Education Office for Civil Rights found that "Nationwide, only 50% of high schools offer calculus, and only 63% offer physics," and that "between 10-25% of high schools do not offer more than one of the core courses in the typical sequence of high school math and science education — such as Algebra I and II, geometry, biology, and chemistry.”
Those who do have access to such classes are typically in wealthy suburban areas. "If you look at where we admit students who are going to have the most amazing careers you can imagine," Andrew Moore, dean of Carnegie Mellon’s School of Computer Science, told the 2017 U.S. News STEM Solutions conference, "you can pretty much map that against a map of the suburbs of regions of the United States which are rich enough to have strong math and computer science programs."
This pattern reinforces the homogeneity in the tech world. Joint research into trends in computer science education by Google and Gallup finds that black students have less access to computer science classes at school and that black and Hispanic students have less access to computers at home. Women and girls, meanwhile, are much less likely to be encouraged to pursue computer science than their male counterparts.
Kids are our next inventors and innovators. Failing to create the deepest possible talent pool by introducing these ideas to as many of them as possible at an early age is a disservice not only to the students but to everyone.
Education and policies aimed at improvements to education can be successful at bridging the divide. Based on its assessment of inequality and opportunity, the RAND Corporation found that "policies that increase education have the potential to reduce inequality among the receiving generation and have impacts on the beneficiaries' children, including (1) improved income position of those receiving financial assistance, (2) increased earnings of those who achieve schooling, [and] (3) general equilibrium effect on returns to schooling."
The Education System Is Slow to Respond to Developments in the Economy and Labor Market.
Beyond the inequality issues, American education has also failed to adapt to the changing needs of the economy and culture.
"We need to rethink our education system," writes Harm Bandholz on the World Bank Jobs and Development Blog. "As robots and machines are capable of taking over a growing number of tasks, humans have to focus on their comparative advantages, including non-cognitive skills."
In the Harvard Business Review, Julian Birkinshaw suggests, "Maybe it's time to put a bit more emphasis on creativity and commercial savoir faire in our education system. … In education the school curriculum focuses on traditional subjects taught in traditional ways, and it pushes students into narrow specialties. Many entrepreneurs claim they succeed despite, not because of, their schooling."
A key finding in a recent report by the National Academies of Sciences, Engineering and Medicine was that as automation "continues to complement or substitute for many work tasks, workers will require skills that increasingly emphasize creativity, adaptability, and interpersonal skills over routine information processing and manual tasks. The education system will need to adapt to prepare individuals for the changing labor market."
In collaboration with Elon University's Imagining the Internet Center, Pew Research Center canvassed "technologists, scholars, practitioners, strategic thinkers, and education leaders" about new educational and training programs, asking whether they will emerge and be able to effectively train workers in the skills required for future jobs. Seventy percent of the 1,408 respondents said "yes." Most of the 30 percent who said "no" believe generally that such teaching adaptation will be able to teach workers new skills at the scale necessary for them to keep up with technological change. And, according to Pew, "Some of the bleakest answers came from some of the most respected technology analysts."
Of course, we should mention that not everyone is sounding the alarms. Jack Schneider, writing in the Atlantic, cautions that, although current practices in school curricula might not be ideal, "Americans should think twice before dissolving into panic over what is being taught in modern classrooms," which, he argues, are not as stuck in the past as sometimes imagined.
Exclusionary and Divisive Ideologies
Dangerous Socioeconomic Trends Are Contributing to the Rise of Disturbing Ideologies.
"Rising inequality and slow productivity gains may be the main economic challenges of the [21st] century," Bandholz writes in the World Bank's Jobs and Development Blog.
The Pew Research Center points out that "a flurry of new research points to the potential of a larger middle class to provide the economic boost sought by many advanced economies." But while a larger middle class may be just what the American economy needs, the middle class continues to decline, resulting in greater inequalities and fewer opportunities for lower-income families.
"A thriving middle class is the source of American prosperity, not a consequence of it," Hanauer wrote in his "memo" to "fellow plutocrats." He continued, "The middle class creates us rich people, not the other way around." Hanauer’s sense of urgency around this issue is obvious:
The Center for American Progress' Report of the Commission on Inclusive Prosperity says at the very outset that "no society has ever succeeded without a large, prospering middle class that embraced the idea of progress." In democratic systems failing to create circumstances in which citizens can provide a "decent standard of life for themselves and their families," the report said, "the result is political alienation, a loss of social trust, and increasing conflict across the lines of race, class, and ethnicity."
The blog of the Harvard University Press, Branko Milanovic's publisher, put it much more pithily when considering his elephant chart: "Cue xenophobia. Cue Donald Trump. Cue nationalism. Cue Brexit."
In Trends in Income Inequality and its Impact on Economic Growth, Federico Cingano writes, "Addressing these trends [in the disparity in the distribution of household incomes] has moved to the top of the policy agenda in many countries. This is partly due to worries that a persistently unbalanced sharing of the growth dividend will result in social resentment, fueling populist and protectionist sentiments, and leading to political instability."
Entrepreneurship and Innovation
Are These the Pathways to Increased Prosperity and Success?
"Innovation has transformed the American economy through the development of automobiles and highways, airplanes, telecommunications, and the internet," write Michael Greenstone and Adam Looney in a Brookings Hamilton Project paper, "all of which have made it progressively easier for businesses to market their products globally and connect their best workers to one another. Innovations like these drive economic growth by helping businesses produce more with less — progress that is measured as rising productivity. As businesses and workers become more productive, the prices of goods and services fall and workers' wages rise, improving our standard of living."
And innovation doesn't have to mean new inventions or technological discoveries, Greenstone and Looney point out. It could mean new ideas about how to reorganize businesses to make them more efficient and productive.
Efficiency is often a buzzword cited to defend shrinking the workforce. And it's worth asking: If artificial intelligence and automation — spectacular products of innovation and entrepreneurialism — are a major cause of job loss in existing industries, how can innovation and entrepreneurialism be the solution to the problem of job losses?
The disruption of industries is inevitable. From the automobile to the sewing machine to artificial intelligence, technology will always be nipping at the heels of job markets as work becomes commoditized. The answer is to figure out how to harness that change to be a benefit to the most people.
Referencing the previously mentioned canvassing of experts from Elon University and Pew Research Center, "The skills needed to succeed in today's world and the future are curiosity, creativity, taking initiative, multi-disciplinary thinking and empathy. These skills, interestingly, are the skills specific to human beings that machines and robots cannot do."
"People will create the jobs of the future, not simply train for them," Microsoft researcher Jonathan Grudin told Pew Research Center, "and technology is already central. It will undoubtedly play a greater role in the years ahead."
Changing the Conversation on Innovation
Our Education System Does Not Produce Innovative or Entrepreneurial Graduates.
Peter Drucker wrote of innovation and entrepreneurship as a discipline. Yet today, decades after he began espousing the benefits of an entrepreneurial society, these subjects are not routinely taught in universities around the country. In fact, according to some commentators, the higher-education experience itself is actively discouraging innovative thinking and problem solving:
"Innovation requires flexibility; it demands experience and knowledge that is both broad and deep," writes Henry Doss in Forbes. "Both. Innovators must be comfortable with pivoting, adapting and changing, often and without hesitation. Innovators must be willing and eager to learn anew, all the time, and to learn quickly. But what kind of learning experience do we present to university and college students?"
Even our country's business schools, some argue, are insufficiently teaching entrepreneurship and innovation. An article published in the Economist, "Those who can't, teach," appeared with the subheading "Business schools are better at analysing disruptive innovation than at dealing with it." The article makes an argument similar to that of Doss, highlighting the tendency of academia to divide into disciplines rather than foster the sorts of cross-collaboration required for innovation.
Popular, Well-Known Models and Paradigms for Driving Innovation Are Misunderstood and Misapplied.
Too often, innovation strategies that have some success are lauded as gospel and applied without enough consideration.
The startup and business communities are still abuzz over "The Lean Startup" — entrepreneur and author Eric Ries’ 2011 bestseller. Even those who have heard neither the book nor of Ries are in tune with the process of creating and managing startups set forth in the book. But the hype over this book has resulted in a broad misunderstanding, and in some instances misapplication, of the lean startup process.
On the misunderstanding front, Ted Ladd, writing in the Harvard Business Review, describes the results of his research on 250 accelerator-program teams and their efforts testing assumptions about their business models through experimentation and customer feedback. Broadly speaking, Ladd's research was favorable to the lean startup method, but he did not find a correlation between the number of confirmed hypotheses and team success (the definition of which may vary among readers). Ultimately, he cautions, "The popularity of the lean startup method is well deserved. But, as is true of any business process, the method must be tailored and employed with reflection and constraints, not blind allegiance."
In a perhaps not-so-indirect way, Ries himself agrees that some innovation paradigms are misapplied or even lack merit. In "The Lean Startup," he writes, "Conventional wisdom holds that when companies become larger they inevitably lose the capacity for innovation, creativity, and growth. I believe this is wrong." He doesn't identify the source of this view, but Clayton Christensen's "The Innovator’s Dilemma" can't have been far from his mind.
The road to innovation is littered with the husks of companies that tried to emulate the strategies of Apple, Google, or Amazon, even though they were built in a completely different way than those companies. As product management expert Alain Breillatt explained in 2009, You Can't Innovate Like Apple. Even Apple and Google are not immune from the problem, as we've seen when they've tried to step out of their comfort zones and innovate the way Amazon does.
The point here is not to criticize the Lean Startup or any other model for innovation. It's to point out that latching onto a trendy new methodology, no matter its merits, can be detrimental — even deadly — to an emerging business if that methodology is misapplied. Following a formula is no way to innovate.
Changing the Way We Think About Innovation
Innovation Can Be Taught.
In recent decades, innovation has been reduced to a vague buzzword meant to signify something toward which everyone strives but from which no one can gain actionable guidance or operational instruction.
But innovation and entrepreneurial thinking are not magic. They can be taught, mentored, supported, encouraged — and existing businesses are in a good position to do that work. They have resources, expertise, and industry and market intelligence.
In some companies, innovation is embodied in a single person, a single position or a single department. Innovation might be a new piece of software or a new technology-enhanced process. But innovation is not a person or a thing. These false narratives are harming companies of all sizes.
Innovation is temporal change and creation. It's simply management taking a forward-looking view to driving the sustainability of an organization. And rethinking innovation is essential to any solution that is responsive to the major developments occurring in our country and across the globe.
An existing business is never going to be that lone genius toiling away in a garage somewhere, inventing the future against all odds. But the good news is, that's not how most innovation works. What works is creativity, planning, intelligence, and skill. Every company in every industry has a choice: Wait for someone else to disrupt your business or create and encourage that innovation yourself.
For those ready to do that work, check out our research and get started.