Amid continuing concerns over inflation and the possibility of a recession, the Federal Reserve meets this week and will release updated long-term projections for US economic growth. As California seeks a strong path forward for its economy, entrepreneurs, and workers, understanding the drivers and constraints of new business growth is essential. New businesses are critical to our national and state economy, in part because they can spur job creation. Between 2003 and 2019, new businesses that had people on payroll (and were less than a year old) accounted for the majority of net job creation annually, which helped balance out jobs lost through business closures or reductions in staffing. Research also suggests that new business applications serve as a strong indicator of future employment and aggregate economic activity. Here we examine how trends in new business applications and creation fared over the course of the pandemic and economic recovery.

Although new business applications fell at the outset of the pandemic, they jumped back up quickly. The number of new business applications for firms that intend to hire in California dropped steeply in April 2020, falling about 20% below pre-pandemic levels. However, just a few months later applications rebounded, with nearly 50,000 new business applications filed in July 2020—the highest number since 2004 when the US Census Bureau began tracking this data. And while there was some volatility during the pandemic, new business applications have remained elevated through 2023.

However, not all business applications lead to new firms with payroll; some remain sole proprietorships or self-employed, and some fail to launch. Using historical trends, the Census Bureau estimates which applications are most likely to become a business with employees within two years. These numbers offer some positive signs; applications with a relatively high likelihood of adding employees (“high-propensity applications”) have been elevated over the past few years. Yet there has been even more growth in business applications that are less likely to become employers (“non-high-propensity applications”). Because it takes time for new businesses to become established and hire, we do not yet know definitively if the uptick in applications during the last few years has resulted in significant numbers of new firms or employment growth.

What types of new businesses have formed in recent years? National trends suggest employer business applications in retail e-commerce, professional and other services, administrative and support services, construction, and transportation and warehousing saw the largest growth. We are not able to examine California’s business applications by sector, but a data source that tracks jobs from new business openings (rather than the business application data shown above) shows some similar trends. In particular, between 2020 and 2022, we see a very large increase in new business openings in the transportation and warehousing sector. Overall, new business openings with employees in California increased by 21% between 2021 and 2022, after falling about 7% between 2020 and 2021.

Recent upward trends in new businesses may have been shaped by unique factors during the pandemic. Some people may have turned to self-employment out of necessity as unemployment spiked precipitously in 2020, or they may have drawn on pandemic financial assistance (such as stimulus payments and pandemic unemployment assistance) for startup capital. In addition, unusually healthy financial markets during the early years of the pandemic and shifts toward increased online consumer activity and growth in digital connection tools may have made new business opportunities possible.

At the same time, the incentives that might have helped new firms or employers launch in recent years are balanced against the challenges of doing so, especially given high costs in California and elevated inflation. Indeed, while some new businesses started in recent years, others shut down, shrank, or relocated. Nevertheless, new businesses and jobs saw positive net changes between 2020 and 2022.

Despite recovery and signs of strength in California’s labor market, there remains considerable uncertainty as to how the state’s economy will evolve over the next several years in the face of inflation, the potential for recession, and long-term challenges like the state’s high costs of living and doing business. New business growth plays a key role in understanding the state’s economic future and we will continue to monitor these trends.