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«Deutsches Institut für Wirtschaftsforschung 2013 Business Cycles, Unemployment and Entrepreneurial Entry First Evidence from Germany Michael ...»

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Deutsches Institut für Wirtschaftsforschung 2013

Business Cycles, Unemployment

and Entrepreneurial Entry

First Evidence from Germany

Michael Fritsch, Alexander Kritikos and Katharina Pijnenburg

Opinions expressed in this paper are those of the author(s) and do not necessarily reflect views of the institute.


© DIW Berlin, 2013

DIW Berlin

German Institute for Economic Research

Mohrenstr. 58 10117 Berlin Tel. +49 (30) 897 89-0 Fax +49 (30) 897 89-200 http://www.diw.de ISSN print edition 1433-0210 ISSN electronic edition 1619-4535

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http://ideas.repec.org/s/diw/diwwpp.html http://www.ssrn.com/link/DIW-Berlin-German-Inst-Econ-Res.html Business Cycles, Unemployment and Entrepreneurial Entry – First Evidence from Germany 1 Michael Fritsch 2, Alexander Kritikos3 and Katharina Pijnenburg 4 March 18, 2013 Abstract We investigate whether people become more willingly self-employed during boom periods or in recessions and to what extent it is the business cycle or the employment status influencing entry rates into entrepreneurship. Our analysis for Germany reveals that start-up activities are positively influenced by unemployment rates and that the cyclical component of real GDP has a negative effect. This implies that new business formation is counter-cyclical. Further disentangling periods of low and high unemployment periods reveals a “low unemployment retard effect”.

JEL classification: L26, E32 Keywords: Self-employment, business cycle, unemployment, start-up We are indebted to Adam Lederer and Dieter Nautz for helpful comments and to Alina Sorgner and Michael Wyrwich for preparing the data on new business formation.

Michael Fritsch is Chair of Business Dynamics, Innovation, and Economic Change at the Friedrich Schiller University Jena, and Research Professor at the German Institute for Economic Research (DIW Berlin); email: m.fritsch@uni-jena.de.

Alexander Kritikos (Corresponding Author) is Research Director at the German Institute for Economic Research (DIW Berlin), Professor of Economics at the University of Potsdam, and Research Fellow of the IZA, Bonn and of the IAB, Nuremberg, e-mail: akritikos@diw.de.

Katharina Pijnenburg is Research Associate at the German Institute for Economic Research (DIW Berlin), email: kpijnenburg@diw.de.

1. Introduction There is an ongoing discussion to what extent the business cycle stimulates the rates of entry into entrepreneurship. In particular the question is whether people rather become self-employed during boom periods or recessions. It is also unclear whether relatively high or relatively low unemployment rates exert an impact on entrepreneurial entries. Thus, it is a puzzling question which macro-level factors influence transition rates into self-employment and in what direction? 5 While there are good reasons to generally expect individual decisions for or against self-employment in response to business cycle fluctuations, there are two competing effects that may occur. On the one hand, potential entrepreneurs may positively react to GDP changes in a way that the number of newly founded businesses and the amount of their investments should increase in an upswing and decline in a downturn. On the other hand, transition rates into self-employment may amplify in recession periods when employment opportunities are rare.

This argument would induce low start-up rates in boom periods when employed positions are more easily available.

Both arguments may relate to different types of new businesses and could have considerable consequences for the economy. Expecting high start-up rates in an upswing and low levels of new business formation during a downturn is usually associated with the assumption that the decision to set up an own business is driven by the desire to realize perceived opportunities. In contrast, new firms that are induced by scarcity of employment opportunities are often regarded to be driven by necessity. As a consequence, opportunity entrepreneurship should There are an increasing number of studies analyzing the factors that influence the transition into entrepreneurship at a micro-level. These approaches revealed that demographic (see e.g. Levesque and Minniti, 2006), educational (Block, Hoogerheide and Thurik, 2012) economic (see e.g. Blanchflower and Oswald, 1998), as well as personality characteristics (see e.g. Caliendo, Fossen and Kritikos, 2009, 2010, 2011,

2012) affect the decision to start an own business.

have a pro-cyclical effect while necessity entrepreneurship would be of counter-cyclical nature. 6 By simultaneously focusing on the relationship between GDP growth, unemployment, interest-rates and self-employment over the business cycle, this paper investigates which macro-economic conditions influence the entry rates into entrepreneurship. Our analysis is – to the best of our knowledge – the first of its kind for Germany where we combine for a 15 year period a variety of data sources that provide us with information on the relevant macro-economic variables.

We show that between 1996 and 2010 unemployment rates have positively influenced entry rates into self-employment. We also reveal that GDP growth has a rather negative effect on entrepreneurial entry rates. Interestingly, when we further disentangle periods of relatively low and relatively high unemployment, we find an asymmetric relationship that points to a “low unemployment retard effect.” This means that the reduction of new business formation at times when unemployment levels are below the trend are more pronounced than the increase of the number of start-ups in periods when unemployment is high.

The remainder of the paper is organized as follows. In Section 2 we present our research questions in greater detail and discuss how the development of GDP and unemployment may influence entrepreneurial entry. We then describe in Section 3 the datasets used for our analysis.

Section 4 is devoted to the econometric approach and the presentation of the results including robustness checks. Section 5 summarizes and discusses our results.

This implies the assumption that there are no longer time lags between the decision to start an own business and putting this decision into practice.

2. Why the business cycle and new business formation may be related Entry rates into entrepreneurship may be influenced by several macroeconomic forces in different directions. According to the “opportunity pull” argument start-up rates should increase during growth periods because of a positive environment for investments, such as growing demand and widespread optimism about the future development. In line with this reasoning, fewer individuals may be willing to enter self-employment during recession periods when future developments appear relatively uncertain and investments are perceived as risky (Rampini, 2004). In a similar vein, Barlevy (2007) argues that entrepreneurs may tend to introduce radical innovations during growth periods; thereby causing acceleration effects as such innovations eventually create further innovative activities that could induce strong increases in GDP. These claims should lead to procyclical effects of economic growth on entrepreneurial activities.

There are, however, also other forces at work that may offset such pro-cyclical effects. Following occupational choice models (see e.g., Davidsson, 2004), people may switch from employment or unemployment into self-employment if starting an own business appears to be more rewarding than the status-quo. In particular, two macro-economic variables, unemployment rates and interest rates, may influence this calculus. First, due to relatively low levels of unemployment benefits, the occupational choice approach suggests that transitions into self-employment may occur more often during recession periods when the level of unemployment is relatively high.

Accordingly, the level of start-ups may be relatively low in boom periods when employment opportunities are available. A second factor that may lead to counter-cyclical effects of new business formation is the development of interest rates. Low interest rates in recessions could stimulate the investment in new businesses while high interest rates in boom periods may prevent some potential founders from setting up their own firm (see e.g. Parker, 2009).

If unemployment combined with low interest rates during recessions indeed stimulates self-employment and if relatively rich employment opportunities and high interest rates in boom periods lead to low levels of start-ups, this may be regarded as an anti-cyclical effect, thus stabilizing the economy. If the “opportunity pull” effect prevails, self-employment could have a destabilizing effect on the economy. 7 The net outcome of these contradicting effects of demand, unemployment and interest rates on the level of new business formation is, thus, an empirical question. There is only little empirical evidence about the relationship between new business formation and the business cycle, and so far it is inconclusive which of the above mentioned effects is stronger. As to the relationship between GDP growth and entrepreneurship, empirical evidence from the 1990s suggests a pro-cyclical influence of periods of growth and recessions on the number of entrepreneurial entries (see e.g. Grant, 1996, for the US, Carrasco, 1999, for Spain). Interestingly, studies for more recent years show no such cyclicality. In particular, Henley (2004) finds a certain persistence of entrepreneurship independent of the business cycle. 8 With respect to correlations between unemployment and entrepreneurship there are also mixed findings. Parker (2009) reports, that 1990s era investigations with cross sectional data find a nonsignificant or negative relationship between the level of unemployment and entry rates into entrepreneurship. Conversely, investigations using Although there is considerable reason to assume that the business cycle affects the level of new business formation, there may also exist a causal relationship in the other direction, i.e. that start-ups have also an effect on the business cycle. While an effect of demand or unemployment on the level of new business formation may occur with a considerable time lag, one may also expect that new business formation is a leading time series if start-ups influence the business cycle. Koellinger and Thurik (2012) found first evidence for such an effect. In our analysis, we disregard possible effects of new business formation on employment in subsequent periods.

This finding is supported by recent research at the regional level which also finds a strong argument for persistence of new business formation in the long run (Andersson and Koster, 2011; Fritsch and Wyrwich, 2012).

data from the 2000s find a positive effect. Research based on timeseries data also arrived at mixed results. Robson (1998) finds no evidence for a recession push effect for Great Britain while Georgellis and Wall (2000) reveal for the regions of Great Britain (more or less in the same time period of the 80s and early 90s) that a positive influence on entrepreneurial entry rates is detected when unemployment increases. Results pointing to a recession push effect are reported for Finland by Tervo (2006) and Tervo and Niittykangas (1994), and for Italy by Foti and Vivarelli (1994). The latter observation is in line with Blanchflower (2000), who analyzed this relationship for OECD countries and finds a positive link only for two countries, Italy and Iceland, while for all other OECD countries he reports a negative relationship between the level of unemployment and entrepreneurship.

Potential reasons to explain the different findings dependent on the date of the analysis are twofold: Either there has been a change in attitudes by individuals toward entrepreneurship during this time period.

This interpretation is in line with the hypothesis of Audretsch and Thurik (2000) who argue for a shift from a managerial to an entrepreneurial society. Or the more recent research had better data quality with more controls available and better methods of analysis (see Parker, 2009).

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