The next great firm probably won’t come from the IE

The Austrian economist Joseph Alois Schumpeter, amid the Great Depression, famously announced in a lecture: “a depression is, for capitalism, like a good, cold douche.” Schumpeter’s statement is based on the idea that the least productive companies will not be able to survive an economic downturn, and that, subsequently, the entrepreneurial spirits will rise in the form of new, more innovative companies (“destructive creation”).

Harsh as it sounds, the incubating success of depressions (or recessions) is undoubtedly true for some of the largest California-born companies: a casual listing of some of today’s most prominent companies confirms that they were created during recessions. For example, Disney first launched in 1929, and Hewlett-packard in 1939. Microsoft was founded in 1975, and Apple in 1976. More recently, Venmo and Uber were started in 2009.

It is still too early to know whether any such giants will rise from the COVID-19 downturn. However, data from the Census’ Business Formation Statistics reveals the growth rate of new companies has accelerated following the pandemic. For example, more than 600,000 applications for new businesses were filed in California during the three years since 2020. That’s a 20% increase from the 500,000 million applications during the three years prior to the pandemic (2017-2019).

The national economy shows a similar pattern: New company applications increased by 27%, from 3.8 million to 4.8 million during the same time period. Data for the Inland Empire (Riverside and San Bernardino counties) show an even larger expansion of new businesses. There were 102,000 new business applications during the two years after the pandemic (2020 and 2021) compared to 67,000 business applications during 2018 and 2019. This is a 50% rise.

In addition, in per capita terms, the data for new business applications for the Inland Empire show 12 new businesses for every thousand residents. New business applications per capita in our region are almost twice as large as the California mean of 5.25 new businesses per 1,000 residents, or more than twice the national mean of 4.97 per 1,000 persons. Setting aside the impressive quantities, would you predict the next great company will incubate here?

The easiest way to answer this hypothetical question convincingly would require the BFS to report the sectors that expanded the most at the county or metropolitan statistical area level. Unfortunately, the BFS only provides us with national industry data. That means we have to dig deeper.

One possibility is to use data from the Quarterly Census of Employment and Wages, or QCEW. In a recent report commissioned by Bank of America and the Greater Los Angeles Chamber of Commerce, I, together with my colleagues from the Inland Empire Economic Council, estimated which industry clusters have grown the most in our region over the past 10 years. The cluster that has increased the most in numbers in the Inland Empire is, not surprisingly, “Distribution and Electronic Commerce.” This means that local growth corresponds to national growth, according to the BFS data. Other clusters which have seen significant growth in the region are: local logistical services, local hospitality, local civic organizations, and local health services. Again, this development mirrors national growth in the BFS data.

When it comes to innovation, and high-productivity clusters, our region’s economy is therefore not distinguishing itself from the average U.S. region. The employment growth in the Inland Empire, with the exception of distribution and economic commerce, focuses on the local market. The data suggests that the region is not producing companies that trade with customers, or companies, in other parts of the country.

In a world where regions are becoming more integrated, and few creative, innovative regions accrue the benefits from new technologies, our region is missing the gains from these dynamics. We are the nexus that connects goods and services produced by different regions in the U.S. and the world, some of which are in the most innovative clusters. Yet, since we only work as a connector, we are missing many of the productivity gains associated with innovation and new technologies.

To increase the likelihood of the Inland Empire producing “great” businesses, we need to attract innovative businesses with new technologies that trade with the rest of the world. Failing to do so makes it doubtful that the Inland Empire will be the birthplace of the next blue unicorn, and Schumpeter’s “cold douche” will be just that.