Entrepreneurship, Economic Conditions, and the Great Recession

• Date: 01 June 2013
• DOI: http://doi.org/10.1111/jems.12017
• Published date: 01 June 2013

Entrepreneurship, Economic Conditions, and the

Great Recession

ROBERT W. FAIRLIE

Department of Economics

University of California

Santa Cruz, CA 95064

rfairlie@ucsc.edu

The “Great Recession” resulted in many business closings and foreclosures, but what effect did it

have on business formation? On the one hand, recessions decrease potential business income and

wealth, but on the other hand they restrict opportunities in the wage/salary sector leaving the net

effect on entrepreneurshipambiguous. The most up-to-date microdata available—the 1996 to 2009

Current Population Survey (CPS)—are used to conduct a detailed analysis of the determinants

of entrepreneurship at the individual level to shed light on this question. Regression estimates

indicate that local labor market conditions are a major determinant of entrepreneurship. Higher

local unemployment rates are found to increase the probability that individuals start businesses.

Home ownership and local home values for home owners are also found to have positive effects on

business creation, but these effects are noticeably smaller.Additional regression estimates indicate

that individuals who are initially not employed respond more to high local unemployment rates

by starting businesses than wage/salary workers. The results point to a consistent picture – the

positive influences of slack labor markets outweigh the negative influences resulting in higher

levels of business creation. Using the regression estimates for the local unemployment rate

effects, I find that the predicted trend in entrepreneurship rates tracks the actual upward trend

in entrepreneurship extremely well in the Great Recession.

1. Introduction

The U.S. Economy lost more than 8 million jobs during the recessionstarting in December

2007. The national unemployment rate rose to over 10%, which is twice as high as it

was at the start of the recession. Many researchers have noted that the labor market

experienced its deepest downturn in the postwar era in the recent recession (Elsby

et al., 2010). Sparking the recession was the housing crisis – housing prices plummeted

since reaching their peak in mid 2007. The national housing price index experienced the

largest decline on record (Federal Housing Finance Agency, 2009). Home foreclosures

also rose rapidly over the past few years. In the one period for May 2010, there were

323,000 foreclosure filings, representing an alarming 1 out every 400 housing units in

the United States (Realtytrac, 2010).

What effect did the recent recession, and recessions more generally, have on en-

trepreneurship? Were would-be-entrepreneurs dissuaded by the recent recession from

This research was supported by the Kauffman-RAND Institute for Entrepreneurship Public Policy through a

grant fromthe Ewing Marion Kauffman Foundation. I would like to thank Susan Gates, John Robertson, Danny

Leung, and seminar participants at the Small Business, Entrepreneurship, and Economic Recovery Conference

at the Atlanta Federal Reserve and the CIRPEE-IVEY Conference on Macroeconomics and Entrepreneurship

for helpful comments and suggestions.

C2013 Wiley Periodicals, Inc.

Journal of Economics & Management Strategy, Volume22, Number 2, Summer 2013, 207–231

208 Journal of Economics & Management Strategy

starting businesses or did they respond to layoffs and slack labor markets by turning to

self-employed business ownership? Business bankruptcy filings and closures increased

sharply in the recent recession (U.S. Courts, 2010), but the effects on business forma-

tion are less clear. Recessions might have a negative effect on business starts because of

the resulting decline in demand for the products and services produced by businesses.

The recent housing slump may have limited entrepreneurship by restricting access to

capital. Equity in one’s home is the main asset for most Americans and represents 60%

of all wealth (U.S. Census, 2008). Home equity and other forms of personal wealth are

important for starting businesses because they can be invested directly in the business

or used as collateral to obtain business loans. Bank loans, venture capital and angel

investments were also difficult to obtain during the recent recession (Federal Reserve

Board of Governors, 2010; PricewaterhouseCoopers, 2010).

On the other hand, the recent recession might have increased “necessity” en-

trepreneurship or business creation because of the rapid rise in the number of layoffs

and unemployment in the United States. Previous studies provide evidence that job loss

and reduced labor market opportunities lead to entry into self-employed business own-

ership (Farber, 1999; Parker, 2009; Krashinsky, 2005). Although the motivation might

differ for starting the business in this case, many of these businesses may eventually be

very successful. For example, a recent study by Stangler (2009) finds that the majority of

Fortune 500 companies were started during recessions or bear markets.

Given these opposing forces, the net effect of the recent recession on business

creations is ambiguous. Indeed, the positive and negative influences may have even

cancelled out resulting in a relatively flat rate of business creation over the business

cycle. To explore this question, I first conduct a detailed analysis of the determinants of

entrepreneurship using newly created panel data from the most up-to-date microdata

available—the 1996–2009 Current Population Survey (CPS). Although the CPS data

are usually used as cross-sectional data, panel data can be created from the underly-

ing data files allowing one to measure business creation by individuals. Using these

data, the effects of rising unemployment rates and the decline in housing values on en-

trepreneurship are examined by estimating the relationship between business creation

at the individual level and local labor and housing markets. The analysis covers two

recessions and two strong growth periods, and uses variation in unemployment and

housing prices from more than 250 metropolitan areas. Estimates from this analysis are

then used to examine whether rapidly increasing unemployment rates and a declining

housing market had a large effect on business creation in the Great Recession.

This study is the first to provide a detailed analysis of the effects of the Great

Recession on business creation in the United States. It also improves on previous re-

search on business formation by capturing a broader range of new business activity

than commonly-used Census data focusing only on new employer firms. Detailed in-

formation on home ownership, initial employment status, education and demographic

characteristics of entrepreneurs and nonentrepreneurs available in the CPS allow for a

much more extensive analysis of the relationship between local economic conditions,

housing market conditions, and business formation than previously conducted in the

literature. The study provides new evidence on the potentially opposing influences of

unemployment and housing markets on entrepreneurship, interactions between ini-

tial employment status and local labor market conditions, and the types of business

created in weak labor market conditions. The findings from this analysis may have

important policy implications because of the focus of many government programs

on promoting business ownership among the unemployed and the potential for job