How the Great Recession Spurred Entrepreneurship

Published: June 21, 2013   Recent Research   In weak local economies, startup numbers are strong. Title: Entrepreneurship, Economic Conditions, and the Great Recession (fee or subscription required) Authors: Robert W. Fairlie (University of California, Santa Cruz) Publisher: Journal of Economics and Management Strategy, vol. 22, no. 2 Date Published: Summer 2013 The U.S. economy shed more than 8 million jobs during the Great Recession, the steepest decline since the end of World War II. But was there a silver lining to the downturn? According to this study, which is the first to use data from the recession to analyze its effect on people’s decisions to start new businesses, this severe shock to the workforce fueled a surge in entrepreneurship. The recession, which began in late 2007, sent corporate bankruptcy filings and closures soaring, of course, but its effect on business formation is less clear. Many sources of angel investments, bank loans, and venture capital dried up. However, the rapid increase in layoffs, the availability of newly unemployed workers, and a dearth of employment alternatives may have combined to create higher numbers of entrepreneurs than in pre-recession years. The author put together a data set using the Current Population Survey from 1996 to 2009, a period encompassing boom times and the dot-com bust as well as the Great Recession, which officially ended in mid-2009. Conducted monthly by the U.S. Bureau of the Census and the U.S. Bureau of Labor Statistics, the survey covers more than 130,000 people in 250-plus metropolitan areas, a sample that is generally considered representative of the overall population. Using the data, the author tracked people who reported opening a new business as their primary job. Side businesses were excluded if people worked more hours at a salaried position. The data provides detailed information on home ownership, level of education, initial employment status, and other demographic markers. This mass of information allowed for a much more comprehensive analysis of the links between local economic conditions, the state of the housing market, and business creation than was possible in previous research, the author writes. A consistent theme emerged across several regression analyses: The lack of better employment opportunities and the chance to take advantage of slack regional labor pools outweighed the downturn’s other effects, such as limited demand for products and a shortage of investors. Indeed, the Great Recession saw the largest increase in entrepreneurship of any period in the study’s 14-year time frame. The formation rate of new businesses went down in 2006, in the lead-up to the recession, and started to increase in 2007 before spiking in 2008. It hit its peak in 2009, when the rate was 17 percent higher than it had been three years before. The only other significant spike reported in the study occurred from 2001 to 2004, the period during which the boom times of the late 1990s gave way to the dot-com bust.  Delving deeper, the author found that the conditions of the local labor market played a major part in whether people started their own businesses. Throughout the approximately 250 metropolitan areas examined in the study, higher local unemployment rates were tied to higher rates of entrepreneurship. The unemployed started more businesses than those who held a job. And homeowners were also more likely to form a business—despite the collapse of the housing market, they apparently had an easier time than nonowners in obtaining loans to finance a startup. Having access to some credit or having a solid borrowing history seemed to give homeowners a leg up when funding was scarce. “All else equal, individuals living in areas with higher home values will have more equity in their homes,” the author wrote, and on average will start more businesses. Interestingly, the types of businesses formed during the downturn are similar to those started in prosperous periods. In fact, the share of businesses created in each industry during boom and bust periods differs by less than a percentage point. The highest number of startups during the Great Recession appeared in the professional-services and construction sectors, followed by education and health services, wholesale, and retail. Manufacturing had the lowest rate. Citing a study from 2009, which found that 57 percent of that year’s list of Fortune 500 firms got their start during previous recessions or bear markets, the author argues that many of the businesses created during the Great Recession could have staying power. “Therefore, one positive byproduct of the recent severe recession,” he writes, “is that a wide range of eventually successful firms might emerge and contribute to the long-run economy.” Bottom Line: The Great Recession caused many businesses to close their doors or file for bankruptcy protection, but the rapid rise in unemployment also drove an increase in entrepreneurship. For many people across the U.S., the potential opportunities from opening a new business outweighed the alternatives, despite slumping demand and tight credit.