Entrepreneurship, down-side risks, and social insurance

When Americans talk about entrepreneurs, or at least the reasons for becoming one, the possibility of great success is most often the first topic of discussion. The great wealth that company founders such as Bill Gates or Mark Zuckerberg amassed certainly make the idea of starting a business more attractive to potential entrepreneurs. But according to a new National Bureau of Economic Research working paper, we should be paying more attention to the down-side risks when it comes to fostering entrepreneurship.

The new paper, by economists John Hombert and David Thesmar of HEC Paris, David Sraer of the University of California-Berkeley, and Antoinette Schoar of the Massachusetts Institute of Technology, looks at a reform in the French unemployment insurance system enacted in 2002. The reform allowed unemployed workers who start a new business to keep the right to their unemployment benefits for up to three years. They could use the accrued benefits to make up the difference between their business’s revenue and the level of benefits they would have otherwise received.

The four researchers find that the policy change acted as a sort of entrepreneurship insurance. Workers who before would have been hesitant to start a business may be more likely to do so now that they had some protection against downside risk. The new paper documents that the rate at which firms were created increased by 25 percent after the 2002 reform.

Were these new entrepreneurs people who would be good at starting a business but were just more risk averse? Or instead were they just people throwing their hats in the ring? Hombert, Schoar, Sraer, and Thesmar find that the new entrepreneurs were quite similar to the old ones and, in fact, slightly more ambitious in their goals. They also find that the newly created firms were just as likely to increase employment — and just as likely to fail — as the older cohorts of new firms.

So the evidence points toward these new entrepreneurs being capable businesspeople who just needed a safety net before starting a business. What’s more, these new firms had a positive impact on the overall economy. The level of total employment in the French economy was unchanged by the reform, but the four economists find that the new firms had higher wages and were more productive than the firms they replaced. The reform helped boost the productivity of the French economy.

Of course, these results are about the French economy. Extrapolating results across economies is always a risky endeavor. As the authors point out, the rate of business creation is much lower in France than the in the United States. So a similar reform in this country might have a smaller impact. But the underlying principle is important to consider. Many U.S. policymakers and economists are worried about the decline in entrepreneurship and business creation. They might want to consider investigating whether alleviating the down-side risks to starting a company can help solve that problem.