Government policy often supports small businesses – the so-called ‘engine room’ of the economy – through lower taxes, lighter labour regulation, and grants. Yet it is actually young firms that play the most outsized role in economic dynamism. Using firm-level microdata, we draw out this important distinction between firm size and age in firms’ economic contribution, highlighting three key facts.

First, young firms are positive contributors to economic growth while small old firms detract from economic growth. For example, young firms contribute 6 percentage points to annual headcount growth, while small old firms detract from annual headcount growth by 4½ percentage points.

Second, there is vast heterogeneity among the performance of young firms. By age five, high-performing young firms employ twice the number of workers than the average firm of the same age and are over 40% more productive.

Finally, firm exit is critical to the economy’s productivity. Exiting firms are roughly 20% less productive than the industry average even five years before they exit. Their eventual exit reallocates resources towards more productive firms.

Policymakers need to: reconsider size-based business policies; better understand the vast differences in performance amongst young firms; and critically review policy-induced frictions to firm exit.