Social insurance and entrepreneurship: The effect of unemployment benefits on new‐business formation

Abstract

This article studies the impacts of social insurance on the decisions of unemployed individuals to start businesses. Exploiting staggered changes in benefit generosity across U.S. states and over time, I find that higher unemployment insurance (UI) benefits both lower the probability that an unemployed person will become self-employed, and also extend the length of time that passes before they make such a transition. The negative effects of UI benefits are concentrated on the formation of unincorporated businesses. Unincorporated businesses created by unemployed people in higher-benefit state-periods tend to be more successful, as measured by profit and survival rate, suggesting that higher benefits mainly screen out the entry of less productive firms. The negative effects are smaller during nonrecession periods and in states that offer a Self-Employment Assistance program.

Unemployment benefits, entrepreneurship policies, and new business creation

“…This broadly supports H1: that generous unemployment benefits discourage individuals from becoming entrepreneurs. When unemployment compensations are large and offered for a long time, the opportunity costs for creating a new business are higher and there is a less entrepreneurial initiative (Parker & Robson, 2004 ; Koellinger & Minniti, 2009 ; Robson, 2010 ; Xu, 2022 ). For a given country, an increase of the average unemployment benefit replacement rate (NNR_AVG) by one percentage point results in a decrease of the nascent entrepreneurship rate with almost 0.04 percentage points, all other things being equal.…”

“…7 Second, NER offers a more comprehensive assessment of the overall process of new firm creation in a country by capturing the setting up of both incorporated and unincorporated businesses. By comparison, the new businesses registered indicator from World Bank’s Entrepreneurship Survey and Database captures only the number of new limited liability corporations created in a year, and there is evidence that the effects of unemployment benefits may be different for incorporated and unincorporated businesses (Xu, 2022 ).…”

“…The design of the unemployment insurance system matters in this equation. Disincentives are stronger when benefits are lost as soon as the unemployed individual gives up looking for a job and starts a new venture, or when business income is deducted from unemployment benefits, and milder when the benefits are still available for the individual while in the process of creating his own business (Hombert et al, 2020 ; Xu, 2022 ). Moreover, social security coverage could be equally relevant to occupational choice.…”

“…Forced out of the labour market, necessity entrepreneurs are more likely to create unincorporated businesses or be engaged in entrepreneurship in the informal sector (Williams, 2007 ), where tax policy has a lesser effect on entrepreneurial decisions and there is less pressure of losing unemployment benefits while in the process of creating a new business. Nonetheless, unincorporated businesses usually have smaller profits compared to incorporated businesses, and, therefore, the decision to create such a business is more strongly affected by generous unemployment benefits when new business income is deducted from these benefits (Xu, 2022 ).…”

“…However, the bulk of the literature seems to focus on the interplay between unemployment benefits and unemployment (among others: Chetty, 2008 ; Ekkehard, 2015 ; Farber et al, 2015 ; Rebollo-Sanz & Rodríguez-Planas, 2020 ; Petrosky-Nadeau & Valletta, 2021 ), and mostly provides evidence that extensive unemployment entitlements, as level or duration, and weak job-search and availability-to-work requirements to keep receiving benefits inhibit job search incentives and reduce unemployment exit rates. That being said, much less attention has been paid to the effects of unemployment benefit systems on entrepreneurial activity in a country, although a few papers directly or indirectly explore this strand of research (Parker & Robson, 2004 ; Kanniainen & Vesala, 2005 ; Hessels et al, 2007 ; Koellinger & Minniti, 2009 ; Robson, 2010 ; Røed & Skogstrøm, 2014 ; Xu, 2022 ). As most empirical studies evidence a negative relationship between generous unemployment benefits and entrepreneurial indicators, this might have led many to believe that the same findings in the unemployment literature apply to entrepreneurship and there is no need for further, in-depth investigation.…”