The Fate of New Businesses in Times Of Recession; Full Employment and Entrepreneurialism.

If you ask small businesses what their number one problem is right now, you will get “poor sales” as the most frequent answer, beating out such issues as taxes, regulation, labor costs/quality, and health insurance. Poor sales, that proxy for aggregate demand, has gone up three and a half times in terms of the “number one” answer since the beginning of the Great Recession.

So I always find it weird when people think that recessions are a time where we can purge out the rottenness and let virtuous new businesses and entrepreneurs take over. Because right now is the worst time to imagine opening a business – all your potential customers are sitting around, hoarding savings and cash, unable to spend. Especially if you had a great idea for a new business, a new business that could create growth and new jobs, it strikes me as more likely to crash and burn in the middle of a recession than during a time of full employment and as such you’ll probably sit on it.

But maybe that’s wrong, and there’s a silent revolution of rottenness purging going on with new businesses blossoming. In order to test out this theory, I grabbed data from the Bureau of Labor Statistics, Business Employment Dynamics, Establishment Age and Survival Data (this txt file specifically).  The data only goes back to 1994, and I’m told it’s hard to get before then.  I haven’t used this data before, so I’m learning it on the fly. This post is part of the learning exercise.

The first hypothesis: right now is a period of fewer new businesses opening. Sure enough, that checks out:

In that graph, each data point is the number of businesses opened over the course of one year previous to the May of that year.   And as you can see, fewer people open businesses in a recession, and many fewer businesses are opening right now.  These numbers aren’t normalized, so even though the economy is larger and there are more people than the early 1990s, there are far fewer businesses opening.

But there’s a problem here.  People choose whether or not to open a business in a recession.  Maybe only good ideas open in a recession and dumb ideas get kicked to the side before launch.  Maybe it is harder to get financing and loans, as people vet these business ideas harder.   If this is the case, then the survival rate for businesses opening in a recession should be the same, if not higher, than those that open outside of a recession.  So let’s see if that is the case, to check for endogeneity, as the kids say.   How does this turn out?

This is the 1 year forward survival rate for businesses that have launched in the previous year.  So a business launched From March 2008 to March 2009 has only a 76.3% chance of being around in March 2010.  As you can see, it’s ugly opening a business in a recession.  The rate of being around a year later is lower.  This is consistent for years later than the first year.

If you check the txt file, you’ll also see that businesses that open in this past recession have the fewest employees going back to the early 1990s.  So as much as employees is a proxy for business complexity, these are the simpler businesses you could open.

So there you have it.  In the past 16 years, fewer businesses open during a recession and the ones that do are more likely to fail within one year.  This Great Recession is particularly brutal for both these conditions. Periods of full employment and strong aggregate demand have so many benefits to them; who knew that entrepreneurialism was part of it too?

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2 Responses to The Fate of New Businesses in Times Of Recession; Full Employment and Entrepreneurialism.

  1. Pingback: Weekly Link Round-Up For November 26, 2010 | Blueleaf

  2. Pingback: SSRN-Internal Sources of Finance and the Great Recession by Michelle Barnes, N. Pancost | Finance Professor Blog

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