Unemployment Risk and Entrepreneurship

Abstract

Understanding the decision of individuals to become a new entrepreneur has long been an important topic among economists. Empirically, I find that (i) unemployed individuals are more likely to become an entrepreneur compared to the employed, and (ii) in response to increasing unemployment rate, the propensity to become entrepreneurs increases for employed workers but decreases for unemployed individuals. To explain these findings, I build an equilibrium search model of entrepreneurship and unemployment with endogenous job destructions. Entry decision into entrepreneurship is affected by an opportunistic effect and a separation effect, which is strengthened by surging unemployment risk in recessions. I show that the unemployment rate during the Great Recession would have been two percentage points higher if separation-induced entry is absent in the model. Also, unemployment benefits can be beneficial to the economy by inducing more nascent entrepreneurs from employment. A self-employment subsidy can boost the aggregate output as well. Finally, a decline in labor share would discourage entry from employment resulting in a smaller average firm size.

Keywords: entrepreneurship, unemployment, business cycle, layoff risk, entry rate

JEL Classification: E24, J64, L26