Does Recession Lead to Increased Small Business Formation?

We released our annual small business trends list this week.  We got a lot of questions related to our forecast that the recession will lead to increased numbers of small businesses in 2009.  Many feel the number of small and personal businesses will decline in 2009 due to the recession.  Here is our response.

Academic literature has long linked rising unemployment to increased small business formation and rising self-employment.  A.R. Oxenfeldt argued in 1943 that when faced with unemployment, many will turn to self-employment.  This is referred to as the "refugee effect." 

More recently, the paper Does Self-Employment Reduce Unemployment empirically shows the refugee effect exists for OECD countries (click here for a summary).  The paper also contains background and citations on the academic research on this topic.  And although some studies question the refugee effect, most agree it exists. 

U.S. data also shows that in the last 2 recessions small business formation has increased.  Below is a chart from Warrilow showing SBA data on small business births and deaths.  As the chart shows, small business births exceeded deaths during the prior two recessions. 

            

These data are for employer businesses.  We have less historical data for personal business (single person, or non-employer businesses) because the government has only been collecting data on them since 1997.  But the 2001 to 2003 recession period saw the number of personal businesses grow from 16.9 to 18.6 million.

And while many forecast errors start with the words "this time it's different," there are several reasons why we think small and personal business formation rates will be higher in 2009 than in past recessions:

1.  The costs of starting and maintaining a small or personal business are substantially lower than in past recessions.  PCs, the Internet and low cost office and communications equipment make it much cheaper to start a small or personal business. 

2.  The risks of starting a small or personal business are lower.  In the 80's and 90's starting or working for a small business was often viewed as negative by large corporate employers.  This meant leaving corporate America to start your own business or work for a small business greatly reduced the chances of returning.  This is no longer the case and many larger corporations now see it as a positive.

3.  The demographic drivers are stronger than in prior recent recessions (see our trends post for details). 

We believe small business failures will also increase in 2009.  The recession is not going to be kind to many small and personal businesses.  Also, many surviving small businesses will see their revenue and income decline in 2009.   

But we think the net impact will likely be an increase in the total number of small and personal businesses in 2009. 

Comments

[Prof. Samuel D. Bornstein]

RE: The Housing Market, Foreclosures, and Job Loss:

On December 14, 2008, CBS’s 60 Minutes had a segment on the 2nd Wave of Foreclosures. They indicated that experts were expecting another wave of mortgage defaults on ALT-A and Option ARMs mortgages which will dwarf the Subprime Mortgage Crisis.

Many fail to realize that there are millions of self-employed smaller businesses, who employ from 1-10 employees, that are holding the mortgages that are going to reset in 2009 through 2012.

These borrowers are Prime and Near-Prime borrowers who hold ALT-A, Option ARMs, Interest-Only mortgages. There are $1 Trillion ALT-As, and $500-600 Billion Option ARMs.

So, here we have a major problem… Not only will these small business owners lose their homes, but there will be the resulting JOB LOSSES on their business failure. Note, although President-Elect Obama is stressing the need to create 3 million new jobs, we must understand that “JOB RETENTION IS AS IMPORTANT AS JOB CREATION”.

A survey conducted by the National Association for the Self-Employed (NASE) disclosed these disturbing facts. The NASE survey is at www.nase.org . See the NASE News for the Survey on Toxic Mortgages.

According to this survey, it is estimated that 3,709,800 small business owners hold Alt-A and other toxic mortgages, and 1,279,800 are already delinquent as they have missed one to three or more monthly mortgage payments at mid-November, before the expected Resets that are scheduled to begin in 4th Quarter 2008 through 2012.

The solution lies in the hands of Congress as they meet in January to structure an economic stimulus package. Congress should take note of this survey and be “proactive” in addressing the situation, rather than “reactive” as the case has been in the Subprime Mortgage Crisis.

We can’t afford another shock to our economic system at this time. This 2nd Wave of Foreclosures which will be caused by the ALT-A and Option ARMs will not only result in Foreclosures, but also Job Loss.

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It's an unbalanced economic slowdown effect, that so many employees have lost their jobs in the recession period with in a few months and now its gaining the previous postioin back.

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