Entrepreneurship in a down economy

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Economic growth and job creation overwhelmingly are about entrepreneurs and investors willing to undertake the risks that come with starting up and expanding businesses.

The U.S. economy, of course, started to turn down in December 2007, with matters getting far worse when the credit meltdown fully hit in the latter part of 2008. After the deepest recession in more than 60 years, some kind of recovery seemed to get underway in the second half of 2009.

The big question is: How durable and robust will this recovery be? The answer largely depends on the current and future well-being of the entrepreneurial sector of our economy.

Figuring out how entrepreneurship and small business weathered the storm over the past couple of years, however, turns out not to be a simple task. In fact, two reports on the state of entrepreneurship and small business offer rather different assessments.

Let’s consider the positive take first. The Kauffman Foundation released its latest “Kauffman Index of Entrepreneurial Activity” in May. This index tries to capture new business owners in their first month of significant economic activity.

As explained in the report: “To create the Kauffman Index, all individuals between ages 20 and 64 who do not own a business as their main job are identified in the first survey month. By matching CPS (Current Population Survey) files for the following month, it is then determined if these individuals own a business as their main job with 15 or more usual hours worked per week in the following survey month. These monthly entrepreneurial activity rates then are averaged to calculate an average monthly estimate for each year.”

For 2009, 0.34 percent of this adult population created new businesses each month. That translated into an average of 558,000 businesses created per month.

The 0.34 percent rate was up from 0.32 percent in 2008, and has crept higher for three consecutive years now. In fact, the 2009 rate was the highest over the past 14 years.

That seems to be good news, and probably surprises many people.

However, the U.S. Small Business Administration’s “Quarterly Indicators” on the economy and small business also came out in May. Its measures of entrepreneurship tell a very different story.

The number of incorporated self-employed – after rising in 2006, 2007 and 2008, for example – declined in 2009 by 6 percent.

Meanwhile, the number of unincorporated self-employed has fallen for three straight years. The 2009 level was down by 2.5 percent versus 2008, and by 7 percent compared to 2006.

The Advocacy report also noted that proprietor’s income fell by more than 6 percent in 2009. For good measure, the story has been grim in terms of sources of capital and credit for entrepreneurial firms. Venture capital investment declined dramatically over the last two years, by a total of 42 percent. On the credit front over the past three years, standards have tightened while loan demand has fallen among small businesses.

So, what can be gleaned from these two analyses? Three points:

First, the numbers on incorporated and unincorporated self-employed indicate that the deep recession forced many firms out of business. So, many previously existing entrepreneurs became non-entrepreneurs at worse, or were pushed into trying to start up different ventures.

Second, the increase in entrepreneurial activity on the Kauffman Index is, at least in part, a function of many people being pushed into the entrepreneurial waters due to losing their jobs. From December 2007 to December 2009, for example, the U.S. economy lost over 8.3 million jobs, according to the CPS. When the economy experiences a big drop in employment, many people are forced into entrepreneurship because they cannot find a new job to replace the one they lost. These often are referred to as reluctant entrepreneurs.

Third, the dramatic decline in access to capital and credit means that many firms closed up due to a lack of funding; other businesses have been unable to expand; and many of those new reluctant entrepreneurs are probably barely surviving due to capital and credit woes.

Even given these negatives, any step up in entrepreneurial activity, as indicated by the Kauffman findings, provides the seed for hope. Whether enthusiastic or reluctant entrepreneurs, these are the individuals who will get our economy moving again, spurring growth and creating jobs.

But credit and capital serve as critical water and fertilizer of entrepreneurship. And unfortunately, misguided government policies – such as costly regulation of the financial industry, and looming tax increases on personal income, capital gains and dividends – will work against entrepreneurial ventures being appropriately watered and fed.

Entrepreneurs are a hearty bunch, and they will build and grow in coming years. But that growth promises to be limited by costly public policies.

Keating is chief economist for the Small Business and Entrepreneurship Council. Reach him at rkeating@sbecouncil.org.