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What Happened To Entrepreneurship During The Recession?

Startup

First Posted: 04/05/11 04:23 PM ET Updated: 06/09/11 06:12 AM ET

They were among the recession's most inspiring stories: laid-off workers who went on to start their own businesses rather than dropping out of the labor force or crawling back to corporate America.

But a recent analysis of Census data calls into question the popular belief that the financial crisis spurred American entrepreneurship. Instead, entrepreneurial activity took a nosedive during the downturn, according to a new paper from the Federal Reserve Bank of Cleveland.

The new report challenges another study that used identical Census data. According to a widely-circulated study by the Kauffman Foundation, a Kansas City-based entrepreneurship advocacy group, new business creation spiked during the recession. Released last May, the study found the monthly rate of people transitioning into self-employment steadily rose from late 2007 to a 14-year high in 2009.

“Kauffman’s findings give only half the picture,” says Scott Shane, the new paper's author and entrepreneurship professor at Case Western Reserve University. “Sure, the number of Americans who became self-employed grew. But that number was dwarfed by the amount of US entrepreneurs whose businesses failed during the recession, and who were forced to exit self-employment.”

As a result, the total number of self-employed Americans shrank to 9.8 million in June 2009 from 10.2 million in November 2007, Census data show. All told, 68,490 more businesses closed in 2009 than in 2007, an 11.6 percent increase in the business closure rate.

"If you have more people giving up than going in, I can’t see how entrepreneurship went up," says Shane.

The main point of contention between the two reports is which measure does a better job of capturing entrepreneurial activity: the net change in the total number of self-employed workers or the rate by which people become self-employed.

One thing both studies can agree on is that the majority of the businesses formed during the recession are not hiring employees in the short term.

But Dane Stangler, research manager at Kauffman, is bullish over the long term. Even though they have not yet hired an employee, “non-employer firms started during the most recent recession will become the employer firms of the next decade," Stangler says.

So will the hoards of new businesses created since the downturn began -- many of which still don't employ workers -- boost the economy?

Even though only three percent of new businesses created without employees eventually evolve into businesses with employees, a 2007 study by the National Bureau of Economic Research found that those three percent made up over a fourth of "young businesses," or companies under three years old with employees. That three percent also accounted for 20 percent of the revenue generated by young businesses.

And relatively young businesses -- not small businesses -- are the biggest engines of job growth, according to Census economists. ‪If these trends are still valid in the post-recession economy, then Kauffman may have been right to focus on the flow of entrepreneurs into the economy during the recession, rather than the total stock.‬

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