First, we learned that business start-ups declined sharply. Now, we learn that job creation was sluggish.
I would recommend trying to understand why these phenomena occurred, rather than relying on preconceptions. I think that there is some real work to be done in unraveling what happened. Commenters, try to refrain from just stating opinions/hypotheses without providing some ideas about testing them.
READER COMMENTS
Foobarista
Mar 24 2011 at 6:21pm
Big startups: VC funding dried up bigtime in 2008, although it’s been going up lately.
Small startups: lots of little businesses are initially capitalized by cash/loans from real estate. When RE prices crashed and loans dried up, this source of capital disappeared.
I work in a bigger, VC-backed startup, and my wife sells little businesses, and we’ve seen both trends.
Boban Kostelic
Mar 24 2011 at 6:22pm
Obama. FDIC. Mark to Market. Community Banks stop lending. Small businesses halt expansion. Start ups, not so much. y=jobs, x1=lending, etc… or something like that.
david
Mar 24 2011 at 7:37pm
Well, what models imply a decline in entrepreneurial exploration during a recession, when capital and labor are cheaper, and therefore exploring new possibilities should be less costly?
(I’ve commented before that PSST should imply countercyclical startup formation, and that the conventional wisdom is already that startup formation is procyclical, as this data reinforces…)
Elvin
Mar 24 2011 at 7:51pm
I’ve always thought that oil prices had a big impact in pushing the economy into a deep recession. If you use the rule of thumb that each $10 increase in oil prices causes a 0.25% drop in GDP, the rise from $75/barrel in June 2007 to $145 in July 2008 alone would have caused a 1.75% decline in GDP. For a weakening economy, this was a staggering blow, especially how rapidly it rose in 2008. (Add in food price increases and my guess is that lower income households had a tremendous decline in discretionary income.) I’m not saying a recession wouldn’t have hit without a rise in oil prices, but it certainly would not have been so deep.
Also, I think a wealth effect hit households. With the ATM Home Equity/Cash Refi machine turned off, consumers addicted to consumption had no choice but to tightened up a lot.
The financial sector had all the headlines, but the main street economy was hurting, too. That was totally neglected in the Financial Crisis Commission’s report.
This means that business formation was hit with a triple whammy: shrinking credit, reluctant consumers (and businesses), and higher energy prices.
Oh, and I guess the increase in the minimum wage didn’t help, but that was marginal.
SWH
Mar 24 2011 at 9:46pm
I work in intellectual property and see and talk to tech startups and potential VC targets. There are new technologies out there that are not being
commercialized and used because either: the perceived risk is too high, or, the perceived return does not justify investment. With this to overcome, it is hard to justify a startup today.
Troy Camlpin
Mar 25 2011 at 1:31am
Wouldn’t job creation necessarily be sluggish if start-ups declined sharply? Over time, businesses become more and more efficient and automated. Thus, they need fewer and fewer employees per unit of production. Thus, older and mroe established companies don’t hire as many workers as upstarts, which are just beginning to figure out how to produce, and thus are full of inefficiencies, including having too many workers (but they are of course not too many, because the efficiencies haven’t been discovered yet). This point to why the stimulus did not and can not work — such money necessarily only goes to already-established businesses, which can expand production considerably without hiring more people. This results in a GDP boost without an increase in employment. Which is in fact what we saw.
As for why the startups seem to fail to start up, I would think one would want to look at venture capital (has it dried up? if so, why?), small business loans (are banks making them? are there more restrictions on making them?) regime uncertainty (how will the health insurance law affect me? what new regulations/regulatory reforms are coming? when?), and barriers to entry (were there changes in regulations that might be actively preventing businesses from profitably entering the market?), just to name the few that come to mind at the moment. How to test? Interview people and ask them. Send out questionaires. It’s used in the other social sciences. Why not economics?
David Pearson
Mar 25 2011 at 9:18am
There is a direct link between new business formation and house prices. Small businesses require start-up capital and collateral; both were provided by the housing bubble. Once house prices fell, so did the potential equity in new businesses. This is not an issue of underwriting standards: even if banks wanted to lend to start-ups, these erstwhile entrepreneurs lack the capital to even get into the door of the bank.
The solution? Raise house prices. Unfortunately, they are declining at the moment. What is the level of non-housing inflation that will finally cause buyers to seek out housing as an inflation hedge? Certainly not 2-3%. This is why Fed policy involves a true trade-off between accepting housing deflation and risking higher (and more volatile) inflation.
R Richard Schweitzer
Mar 25 2011 at 10:50am
1. Start by dropping the use of the highly generalized term start-ups.
2. Be specific about the areas of business (especially services) activities in which there are clearly identifiable trends in the ways in which production, distribution and consumption have been (and are) developing.
3. Examine transaction costs and the factors (taxes, regulations, political expectations, etc.)affecting them [See, Coase].
As Jacques Barzun once put it “Start Here” and you will find the other questions to deal with.
Ironman
Mar 25 2011 at 11:58am
Hypothesis: A period of deflation took hold in the last quarter of 2008, which continued through the first half of 2009, making it more relatively expensive to both launch new businesses and to hire workers during that period. Additional factors then increased the real cost of hiring new workers after the deflationary period subsided.
How to Test It: Identify classes of wage-earners whose jobs are extremely sensitive to changes in the real wage level and determine if periods of declining hiring activity can be correlated with deflationary or near-deflationary periods.
Want to Get Started?: See here…. Just as a quick note, the data in the second chart isn’t an apples-to-apples kind of comparison, which I’ll be revisiting in the very near future.
Tom
Mar 25 2011 at 10:10pm
David-
The Austrian Business cycle predicts lower entrepreneurship during recessions that are accompanied by government intervention.
It isn’t a straight cost thing- its a return thing. Would you rather buy a restaurant from a guy retiring because he had made tons of money off it or off a guy who is going out of business? The probability of success seems higher (and might well be higher) when all businesses are doing well even if the average return is modest when compared to the possibility of outstanding returns in an much less certain environment.
A second issue is also that “wealth” is pro cyclical. Having a large sum of wealth be it in cash, your house or in the market makes failure a lot more manageable. Starting a business shortly after your retirement plan took at 30% hit due to a downturn seems a lot scarier than starting one when your retirement account is doing 10% better than you had planned for.
david
Mar 26 2011 at 10:29am
@Tom
This is a very New Keynesian attitude!
As for your point about ABCT, presumably the assumption here is that intervention advances during recessions, thus outweighing the reduced costs of entrepreneurship? This seems like a testable prediction, since some countries respond to recessions with spending, whilst others resort to austerity. In any case, procyclical startup formation is what mainstream models predict, too.
Tom
Mar 26 2011 at 3:57pm
Actually its an old Austrian attitude. The basis of ABCT is that entrepreneurs use prices to make decisions and that central banks monkeying with interest rates lead to different (poor) decisions that would have otherwise been made.
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