It’s no secret that we at the Foundation think entrepreneurial activity benefits the economy. Working off this premise, we often promote policy changes that lower barriers to becoming an entrepreneur along the following lines of logic:
However, this series of events is far from obvious. Another outcome seems entirely plausible:
Essentially, more companies is far from given to be an unalloyed good so we cannot be certain that a simple increase in the number of business is a net positive.
An excellent new empirical paper by Hombert, Schoar, Sraer and Thesmar presented earlier this month at the American Economic Association’s annual meetings investigates one such instance of lower barriers (the paper, Should We Make it Safer to Start a Business?”, is not yet publically available pending publication but we will post it here when it is). They measured the effect of a decrease in cost of entry by studying a large French reform intended to encourage unemployed people to start businesses. Not unsurprisingly, they found that more firms entered after the reform went into effect. They also found the new firms not to be of lower quality than start-ups previous to the reform—they are just as likely to succeed and to create new jobs. They do find evidence of crowding out--that is the number of incumbent firms decreases in response to the influx of new firms, with the job creation from new firms offset by job destruction in dying firms. However, they also find those old firms that exit to be less productive than their young counterparts, a narrative consistent with Schumpeterian creative destruction. So on net, they find that lower barriers don’t actually create more jobs but do improve productivity.
This seems to be a clear tally in favor of the first narrative. I wonder, however, about two more things. First, while it seems clear that the effect on welfare is positive given the large productivity gain, I still wonder how these gains compare to the cost of publically financing the reform and the implications for Pareto efficiency.
Second, surely not all barriers to entry are equal? That is, removal of some will result in more innovation while others will result in more productivity while still others may lead to the second narrative above. Perhaps the paper would benefit from a theoretical model that would clarify the mechanism.