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Ideas Made to Matter
Well-designed unemployment benefits can help create new businesses
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As the federal government continues to dither over aid to jobless Americans, research from France shows how unemployment benefits can help spur the creation of new businesses crucial to economic recovery.
A paper co-authored by MIT Sloan professors andamong others, examined a change to unemployment benefits in France during a recession in the early 2000s.
The study found that offering unemployment benefits for three years — even to recipients who founded a company during that time — resulted in a 25% jump in new business creation.
“It’s a massive increase,” Thesmar said. Providing would-be entrepreneurs with continued unemployment benefits allowed people to take the leap and find out if they were cut out for starting a business or not.
It’s an approach that the U.S. would be advised to consider amid continued high unemployment and the shuttering of millions of small businesses, Thesmar said.
A steady fallback
In France, prior to 2002, unemployed individuals lost their access to benefits if they started a business. Following a rule change that year, workers could collect benefits that closed the gap between their new business income and the amount of unemployment they originally qualified for.
For example, if a worker who qualified for €1,200 in monthly benefits opened a taco truck that turned a €400 profit every month, they would still receive €800 a month to cover the difference for three years. If their business failed, they’d go back to receiving their full unemployment benefits until the three-year timeframe expired. If the business’ own profit exceeded €1,200, they would not receive unemployment benefits but retain their rights until the end of the three-year period.
The researchers wanted to know how much of a difference the rule change made in spurring entrepreneurial activity and whether it led to the creation of quality businesses.
In France, the number of newly created small firms increased by 25% after a change to unemployment benefits coverage.
To find out, they pulled data from the French statistical office (the equivalent of the U.S. census) — specifically, employment and sales figures on small firms (such as cab drivers), which they followed over time to see whether they flourished or not.
They found the number of newly created small firms increased by 25% between 2003 and 2006. But the bigger surprise, Thesmar said, was that these businesses were not of lower quality.
New firms established during the recession performed no worse than the firms created during positive economic times — they were just as likely to record sales growth and hire employees.
“It’s exactly the same quality of firm,” Thesmar said. “Overall, this disproves the theory that barriers to entrepreneurship are there to select the best entrepreneurs. Everyone has potential. The government should encourage experimentation.”
Entrepreneurs are crucial to economic recovery
It’s an idea the U.S. would be advised to consider, Thesmar said. “In the design of these longer unemployment insurance plans, it would be critical to make sure that people who want to start a business can still retain their rights to draw from unemployment benefits."
The government shouldn’t take benefits away from would-be founders, he said, because it reduces the incentive to create a business. “In a time where firms are basically firing people, a good source of new job creation is new companies where people actually create their own jobs.”
In addition, Thesmar said, these new jobs often fulfill needs that would otherwise go unmet during a time of massive disruption. For example, as stores close their brick-and-mortar operations amid the pandemic, the need arises for new online options, where consumers feel safer shopping.
“Employment in itself is not just the only metric by which we should judge a reform like this,” Thesmar said. “You will have a replacement of old firms by new firms, and that’s good. We found evidence that those new firms are better, they provide better services.”
No magic number
While lawmakers have been debating what to include in the next round of pandemic relief, one outstanding question is for how long to offer aid — three months? Six months? A year?
Thesmar said that the results from the study suggest “there’s no magic number.” What’s crucial is making sure that people aren’t penalized for starting a business; they should still receive their benefits dollar for dollar.
“It’s not so much the length,” he said. “What’s important is to match exactly. Entrepreneurs are really providing a public good in a sense. They should be rewarded for it.”
The paper was published in The Journal of Finance in June and, along with Thesmar and Schoar, was co-authored by Johan Hombert, associate professor of finance at HEC Paris, and David Sraer, professor at the Haas School of Business and at the department of economics at UC Berkeley.
