Executive Summary

The mix and character of businesses in the United States have changed dramatically over the past 30 years. The economy is more integrated and interdependent globally; it has become much less reliant on the manufacturing sector; and new technologies have transformed the nature of work. These transformations have resulted in a highly dynamic economy with outcomes varying over time by sector, region, and segment of society. Business firms, as well as the one or more establishments that comprise them, are constantly changing, with the people who start and run them frequently reinventing their careers. The pace of establishment entry and exit is rapid, especially in the expanding service sectors—additional flux in the economy is created as companies reorganize through mergers, acquisitions, and divestitures. Moreover, it has become more difficult to classify a business as manufacturer, wholesaler, or retailer. Even the physical location of business activity has become more difficult to track, as information technology permits key inputs for some industries to electronically connect into the production process from anywhere in the world. The blurring of boundaries implies that measuring business activity increasingly requires tracking the connection between employers, employees, and independent entities.

The dynamic U.S. economy poses challenges to policy makers at the national, state, and regional levels who seek a more complete understanding of the factors that enhance productivity and innovation, as well as how different sectors and regions participate in the economy. This understanding is provided by the analyses and interpretations—which are in turn



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Understanding Business Dynamics: An Integrated Data System for America’s Future Executive Summary The mix and character of businesses in the United States have changed dramatically over the past 30 years. The economy is more integrated and interdependent globally; it has become much less reliant on the manufacturing sector; and new technologies have transformed the nature of work. These transformations have resulted in a highly dynamic economy with outcomes varying over time by sector, region, and segment of society. Business firms, as well as the one or more establishments that comprise them, are constantly changing, with the people who start and run them frequently reinventing their careers. The pace of establishment entry and exit is rapid, especially in the expanding service sectors—additional flux in the economy is created as companies reorganize through mergers, acquisitions, and divestitures. Moreover, it has become more difficult to classify a business as manufacturer, wholesaler, or retailer. Even the physical location of business activity has become more difficult to track, as information technology permits key inputs for some industries to electronically connect into the production process from anywhere in the world. The blurring of boundaries implies that measuring business activity increasingly requires tracking the connection between employers, employees, and independent entities. The dynamic U.S. economy poses challenges to policy makers at the national, state, and regional levels who seek a more complete understanding of the factors that enhance productivity and innovation, as well as how different sectors and regions participate in the economy. This understanding is provided by the analyses and interpretations—which are in turn

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Understanding Business Dynamics: An Integrated Data System for America’s Future heavily dependent on the federal business data system—conducted by the academic and statistical agency research communities. Business data collected by the statistical agencies are useful for a broad spectrum of research, policy, and commercial purposes. They provide key building blocks for national and local statistics on income, economic output, employment, productivity, investment, and prices. Beyond these headline statistics, micro-level business data are integral to analyses of job creation and destruction, worker flows, opportunities for economic advancement, firm and establishment entry and exit, technology adoption, innovation, business owner characteristics, outsourcing, interactions among firms, and even the impact of natural disasters on local economic activity. Given these wide-ranging interests, the Panel on Measuring Business Formation, Dynamics, and Performance was asked to develop strategies for improving the accuracy, currency, coverage, and integration of data used in academic and agency research on these topics, as well as data used in the production of key national (as well as regional and local) statistics. The panel’s charge was to (1) catalogue currently available databases, focusing on those produced by the federal statistical system; (2) identify gaps in data sources that impede the production of accurate and timely statistics and that hamper research on business dynamics; and (3) develop recommendations for more effective integration of data sources and for new and improved collection of business data, recognizing legal impediments, survey response rate and burden considerations, and access and confidentiality issues. Given its historically predominant focus on large and mature businesses, the current federal business data system was designed to provide efficient measures of gross output and net job creation. This is the case because a relatively modest number of well-established businesses account for a large share of the nation’s aggregate economic activity. As it stands, however, the U.S. business data system is inadequate for understanding many of the mechanisms leading to greater productivity and innovation or the dynamics of firm and job creation. The drawback to the current approach is that, when business dynamics vary systematically with business size or age, it can yield less accurate, potentially misleading, measures of changes in economic activity. Over the past decade, U.S. statistical agencies have markedly improved the measurement of business activity through the development of longitudinal databases, constructed in large part from administrative records. Private research foundations have also supported improvements in databases on young and small businesses. Nonetheless, substantial data gaps remain. The panel presents a series of recommendations, all consistent with current norms and standards for use of government data in the United

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Understanding Business Dynamics: An Integrated Data System for America’s Future States, for improving the understanding of U.S. business dynamics. More specifically, we recommend working toward a business statistics system that includes better measurement of young and small businesses, richer analyses of their economic performance and role in the larger economy, and more reliable, timely, and accessible data on entrepreneurial activities. If these recommendations are adopted, this new data system will substantially enhance the capacity of researchers to understand U.S. business and employment dynamics and assist policy makers as they react to major competitive challenges across sectors and geographic regions. While several of the core recommendations could be implemented at low cost (at least in the long run), others would require significant adjustments to current data systems. Reorientation of the data system as described in this report is needed to address numerous important questions: How, and how much, do young and small businesses contribute to innovation and productivity growth? How important are these businesses in the generation of jobs? Do differences in the entrepreneurial characteristics of business enterprises help explain regional differences in economic performance? And do new and small businesses offer good opportunities for minorities, women, immigrants, and those with less schooling to become part of the economic mainstream? To advance research on the role that new businesses play in the evolution of the economy, richer data are needed on business enterprises, business owners, and the legal, fiscal, and economic characteristics of the environments in which they operate. The “ideal” data system must be capable of integrating data from an array of sources—private and public, business- and household-based, cross-sectional and longitudinal, survey and administrative, national and subnational—that permit business dynamics to be measured in ways that are just now being conceptualized. BROAD PRINCIPLES During its deliberations, the panel identified four principles to guide its work and, in turn, the development of its recommendations: Confidentiality: The statistical agencies have a responsibility to data providers and data subjects to protect the confidentiality of information that is provided. Data collected by the government must be maintained in such a way that identifiable information is not disclosed for administrative, regulatory, or enforcement purposes. Public Purpose: Subject to confidentiality requirements, data sharing among government statistical agencies and data access by others should be facilitated when it serves a substantial public purpose. Data uses that serve a substantial public purpose include those that lead to improvements

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Understanding Business Dynamics: An Integrated Data System for America’s Future in the quality, breadth, and usefulness of government statistics; provide evidence crucial to informing government policies on social and economic issues; and encourage research that advances scientific knowledge. Targeting Deficiencies: Improvements to data collection should focus first on areas in which policy and research relevance is high but in which statistics needed to inform those policies and research are weakest. This implies building up the statistical infrastructure for measuring business dynamics and collecting information on rapidly growing economic sectors in which the activities of smaller and younger firms are disproportionately important, but for which data coverage is relatively weak. Cost Efficiency: The statistical agencies should give the highest priorities to actions that can be done expeditiously and at low cost. Throughout this report, we identify situations for which more creative use of existing data can be exploited for the purpose of producing useful statistics. RECOMMENDATIONS The recommendations in this report are organized into three thematic groupings. The first set of recommendations confronts the need to increase the statistical system’s capacity to measure activities of nascent and young businesses—especially those positioned in fast-growing and innovative sectors of the economy—that are central to understanding business dynamics. The second set of recommendations outlines actions to improve the coverage and depth of business data through more effective coordination and integration of existing information sources. These recommendations reflect the need to improve business data while recognizing that statistical agency budgets are tight and that containment of respondent burden is essential. The third set of recommendations is directed toward shifting the legal and organizational environment to accommodate data sharing and confidentiality protections in such a way that enables the kinds of efficiencies envisioned by the panel to occur. The panel’s broadest recommendations for helping guide the plans of statistical agencies are listed here. Steps that can be taken to improve specific surveys and business lists are detailed in Chapter 5. Expanding Data on Young and Nascent Businesses In designing a data collection system, nothing is more fundamental than the question of whom to survey. The optimal mix of established business entities to be covered in the statistical system’s surveys, censuses, and administrative sources must be determined. For measuring business dynamics, it would be beneficial to reduce the undersampling of those parts

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Understanding Business Dynamics: An Integrated Data System for America’s Future of the business population that are most likely to be in transition and that provide early indicators of the future directions of the economy. To measure business dynamics more effectively, the Census Bureau and the Bureau of Labor Statistics (BLS) should increase the sampling of younger units in their surveys. This will require that business age be included as one of the stratifying variables and that business lists, on which the surveys are based, cover recent business entrants. Given the panel’s conclusion that essential policy-based research relies on information about new businesses, it follows that key data programs must keep track of how long business entities have existed. Business statistics in the federal system are regularly disaggregated along other dimensions—by firm or establishment size, for example—but very little information is systematically produced or tabulated by age. However, it is clear that a better understanding of dynamic trends in industry evolution, firm entry into markets, and the productivity impact of new firms requires data on business age. The Census Bureau and BLS should exploit their administrative record systems to produce public-release statistics on economic activity disaggregated by indicators of business age. Readily available business age indicators in these administrative records systems include the application date for an Employer Identification Number, the point at which positive revenues are generated, and the first period with positive payroll. A focus on publishing statistics by business age would also be compatible with the recent innovations in measuring producer dynamics, such as those developed in association with the Business Employment Dynamics (BED) program produced by BLS and the Statistics of U.S. Businesses (SUSB) produced by the Census Bureau (and the closely related Longitudinal Business Database (LBD) microdata program at the Census Bureau). Because current data collection focuses on larger business entities and traditional sectors and employment arrangements, activities associated with some of the most interesting and rapidly changing components of the economy are imprecisely, or slow to be, detected. Measurement and analysis of the processes through which businesses are born and grow require going beyond conventional data collection from employer businesses. The most direct way to get at early life-cycle dynamics involves focusing on household or individual units. While there are limitations to household-based data, such as the typical absence of information on business performance, they can be used as a screening vehicle for identifying nascent and young businesses and, subsequently, for generating information on their

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Understanding Business Dynamics: An Integrated Data System for America’s Future transitions to more substantial business entities. Optimally, to form as rich a picture as possible, information on worker and entrepreneur characteristics, self-employment, and household-centered businesses should be integrated in a longitudinal data infrastructure. Improving Measurement of Business Dynamics Through Efficient Use of Existing Information Sources Given finite, often tightening, resources, a realistic strategy to improve business data must rely heavily on effective use of existing data collection efforts. Many of the measurement objectives described in this report can be achieved without major new investments; they require only improved coordination of currently available data. A key aspect of the strategy to make more effective use of existing resources involves overcoming technical and legal hurdles so that administrative data that are routinely collected from (and by) businesses can be broadly exploited. For example, major sources of data on self-employed individuals are administrative—tax return information, such as that contained in Schedule C returns, is particularly important. Use of administrative sources can (1) improve data accuracy, particularly when survey questions require respondent recall; (2) broaden population coverage; and (3) reduce respondent burden by minimizing the amount of information that must be gathered in duplicative surveys. Effective use of administrative data allows surveys to be used in a targeted way when detailed information on special topics is needed. In order to take advantage of disparate sources, it must be possible to link records at the individual entity level. For measuring business dynamics, it is particularly important to develop a linking strategy that allows construction of comprehensive longitudinal data structures that capture events as they take place over the course of a firm’s or an establishment’s life cycle. Many of today’s surveys and censuses have longitudinally incompatible questionnaires. More weight should be given to the longitudinal uses of these data when survey instruments are created and revised. The Census Bureau should develop a fully integrated longitudinal household-business data infrastructure from administrative data to serve as a platform for tracking business formation, for integrating household and business survey data for measuring economic activity associated with the business formation process, and for developing samples for new surveys of business dynamics. The integration should include the master household address files, the job frame from linked employer-employee administrative records, and

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Understanding Business Dynamics: An Integrated Data System for America’s Future data for firms (including those with no paid employees, but with receipts) from the Census business register. An efficient data collection infrastructure also requires that survey programs be well coordinated across statistical agencies. It is not economically efficient to expand the Census Bureau’s surveys to include more information, or to collect it at more frequent intervals, when similar data are already collected in BLS surveys. Similarly, it is not efficient to add output and nonlabor input measurements (such as capital investments) to BLS high-frequency surveys. However, periodic measurement of all these concepts on the same questionnaire (and from the same entities) is the only way to identify and correct errors in the estimation of dynamic relationships that occur when the microdata from multiple sources are aggregated for use in statistical products. BLS and the Census Bureau should jointly develop intermittent topical modules for their business surveys. These topical modules should be designed to allow periodic measurement in the same survey and with the same business sample of variables usually collected in separate surveys and at different frequencies. Statistical agencies may also be able to improve the accuracy and timeliness of their products by tapping into data systems maintained by businesses. Given that businesses must continually update their own employment, payroll, capital expenditure, and other records, it makes sense to develop conduits from internal reporting systems to government data collections. By recognizing that companies maintain accounting systems associated with day-to-day operations on a high-frequency basis, it may even be possible to mitigate business respondent burden. New technologies (e.g., web-based reporting) will continue to enhance these kinds of opportunities to improve the timeliness and accuracy of collection efforts. Improving the Business Lists Through Interagency Data Sharing Four business registers in the United States provide wide-scale coverage of both publicly and privately held businesses: three are maintained by government agencies (the Internal Revenue Service (IRS), BLS, and the Census Bureau), and one is private (Dun & Bradstreet). The registers at the Census Bureau and BLS are the primary lists from which statistics on firm and establishment dynamics are generated. The two main programs on business dynamics—the BED and the SUSB/LBD—are constructed from microdata on establishments in these files. The BLS data come from the Quarterly Census of Employment and Wages program administered by the state Unemployment Insurance programs. The Census Bureau program is

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Understanding Business Dynamics: An Integrated Data System for America’s Future based on IRS filings augmented with data from various censuses and surveys. The business lists serve a number of critical purposes. They are used to create sampling frames for a wide variety of surveys conducted by the agencies; to benchmark survey data; to publish employment and wage data; and to generate key statistical aggregates, most notably many of the inputs to the national income and product accounts. Comparison projects conducted cooperatively between the Census Bureau and BLS indicate that the business lists do not consistently align—for example, in terms of employment and establishment counts assigned to certain industries, or in their ability to pick up small and new businesses. Inconsistencies in the business lists carry direct implications for the reliability of key business statistics—from gross domestic product, to aggregate employment, to productivity and industrial production—derived at least in part from business list data. In turn, this creates problems for data users. Perhaps most notably, the Federal Reserve’s monetary policy is affected when productivity data—calculated using output data from the Census Bureau and input measures (industry employment) from BLS—are inaccurate, because that information factors directly into measured inflation trends. Continued evolution of the U.S. business data system hinges, to a significant extent, on improving the Census Bureau and BLS business lists. The potential of reconciling the business registers is a highly visible example of what can be gained through effective interagency data sharing. Recent legislation—specifically the Confidential Information Protection and Statistical Efficiency Act of 2002 (CIPSEA), which allows sharing of confidential business data among BLS, the Bureau of Economic Analysis (BEA), and the Census Bureau for statistical purposes—provides a foundation facilitating the kind of data coordination needed to work toward this goal. However, the Census Bureau is not permitted to share its underlying business list or survey data with BEA or BLS because they are commingled with federal tax information. The panel supports extending CIPSEA to increase the flexibility with which information can be shared among statistical agencies for purposes of constructing a comprehensive business register and for designing special surveys. Effective coordination of the statistical agency data programs is essential for improving the accuracy, coverage, and timeliness of business data, as well as the efficiency with which they are produced. Before work can progress further to reconcile the business lists, and before data sharing among the three CIPSEA-designated agencies can be fully exploited, the IRS regulations and tax code legislation must be changed. Measures should be taken immediately to facilitate the expansion of CIPSEA to increase the kinds of information that may be shared

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Understanding Business Dynamics: An Integrated Data System for America’s Future among statistical agencies for the purpose of reconciling the business lists and for the design of special surveys. This expansion of data sharing can be accomplished by: (1) Congress acting to revise Internal Revenue Code Section 6103(j) to extend authorized access of IRS tax information to BEA and BLS; (2) the Treasury Department initiating an update of the IRS regulations, which clarify the purpose and detail specific items that can be shared with authorized agencies; or (3) a combination of both actions. The goal of the agencies charged with creating and maintaining the source lists should always be to include accurate data on all business units, large and small, new and old. There are, according to the Census Bureau, roughly 18 million nonemployer firms—individual proprietorships, partnerships, or corporations with no paid employees—that account for about three quarters of all firms and a reasonably large fraction (12 percent in 2000) of aggregate U.S. business revenues. Thus, sharing of business data would be quite limited if it did not permit an integration of data on the full range of businesses operating in the economy. In order to create a comprehensive business list and to generate data that would be useful for studying the dynamics of small and young firms, interagency sharing agreements should extend to data on nonemployers. Data on all sole proprietors and partnerships must also be included, whether they have employees or not. We believe that a compelling data-driven case has been made, in this report and elsewhere, that reconciliation of the business lists would better serve downstream users—such as BEA in the production of national accounts, the Federal Reserve in carrying out research to inform monetary policy, and the Congressional Budget Office in projecting real gross domestic product growth—to an extent that more than warrants the actions recommended here. The political and legal feasibility of expanding data sharing among the statistical agencies has been enhanced by CIPSEA; indeed, given the uniform set of requirements enacted through CIPSEA, the agencies are now in a better position than ever before to protect data collected for statistical purposes under a pledge of confidentiality. Increasing the Value of Data Collection by Expanding Use The statistical agencies rightly view themselves primarily as data producers, and their mission is to do so, maximizing quality subject to budget constraints. While the agencies do maintain skilled in-house staffs, the vast share of research expertise resides elsewhere, at universities or other nongovernmental institutions. It is the intensive use of statistical agency prod-

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Understanding Business Dynamics: An Integrated Data System for America’s Future ucts that creates their high public value and also exposes their strengths and weaknesses, which ultimately feed back to improve the quality of surveys and of the data sets (public use and restricted access) themselves. A full return on the nation’s investment in data requires that users have access. The quality of research based on business data produced by the statistical agencies would improve with greater interaction between outside researchers and businesses and the statistical agencies. As recommended in previous Committee on National Statistics reports, statistical agencies, in particular the Census Bureau, should incorporate into their missions a broader interpretation of the criteria for access to data. Specifically, research that informs social and economic policy should be considered a valid reason for accessing confidential data. The panel commends recent steps taken by the Census Bureau and IRS to emphasize the importance to public and private decision making of research that takes place at the agency’s data centers, and to work out procedures to facilitate streamlined processes for reviewing proposed research projects. In planning a data system capable of measuring business formation and dynamics, it is essential to keep in mind the needs of users—federal agencies and researchers, as well as businesses themselves. Questions about business activity are frequently made in reference to specific places, ranging from neighborhoods to the entire country. Thus, for many purposes—such as state and local planning—data must be collected and accessible in a way that allows for small-area analyses. Data with precise location identifiers are also needed to document the effects of federal government policies and actions. The impact on local economies of base closures, contract awards, emergency relief, and extending eligibility for unemployment insurance are but a few examples of situations in which the capacity to fully analyze events has been compromised by data limitations. The importance of tracking businesses and people at substate levels has been reinforced by the series of recent natural disasters that have disrupted and redirected many kinds of business and worker activity. Designing useful data systems therefore requires building in the capability to readily aggregate to a range of geographic scales. The statistical agencies have done a good job of integrating small-area details in many of their data programs. Survey programs should continue to collect, and administrative record systems should maintain, data that enable (1) identification, for authorized purposes, of detailed geographic and sectoral location of business activity, generally at the establishment level; and (2) flexible aggregation of statistics by product, industry, region, county, etc. Because point-level geographic identifiers uniquely identify a site of

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Understanding Business Dynamics: An Integrated Data System for America’s Future business activity, issues of confidentiality arise and access to these kinds of data is typically restricted. Costs and Priorities Actions associated with two of the report’s core themes involve minimal increases in resources yet have the potential to yield high value. These themes are (1) that the statistical agencies should maintain their business registers in a more fully coordinated manner and (2) that statistical agencies should utilize the registers to produce new tabulations of economic activity, specifically by business (establishment) age. The recommendations associated with these themes should be given high priority. The report also includes recommendations that would require greater resources or longer term effort to carry out. The rationale behind several of these is that young and small establishments should be given more weight in survey sampling than their receipts or total employment might suggest, because their characteristics change quickly and because they may contribute disproportionately to economic growth. These recommendations are equally if not more important for measuring business dynamics, but the pace at which they can be implemented will be slower. Other recommendations, such as those suggesting more rapid integration of new technologies or more effective use of existing data sources, are offered to encourage long-term efficiency of business data collection. Taken as a set, a major justification for the panel’s recommendations is to avoid the costs of “benefits foregone” from the absence of timely, precise data on the mechanisms by which the U.S. economy adapts and grows. In our view, the amount of resources required to provide a more timely, accurate, and complete description of U.S. business dynamics seems like a very good investment of public resources, yielding substantial benefits for future generations.

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