With governments around the world introducing a range of support mechanisms to help people through the economic turmoil caused by the Covid pandemic, many pondered whether this financial support might limit people’s propensity to find work. Research from Shanghai Jiao Tong University suggests it might not affect our likelihood of finding full-time employment, but it does appear to affect our likelihood of becoming self-employed.
The researchers gathered data from the U.S. Department of Labor on the maximum unemployment insurance benefits in each state, while also surveying the labor department in each state to understand how the policy affects the creation of a new business in terms of its eligibility.
Unintended consequences
“This result is a little surprising at first glance, as we would have thought that higher unemployment benefits might offer support to those people who try to start their own business, leading to more new businesses,” the researchers explain.
The study found, however, that most states require any profits made in your business to be deducted from one’s unemployment benefits, which disincentivizes the creation of the business. What’s more, the researchers argue that higher benefits can dampen enthusiasm for leaving unemployment more broadly.
Interestingly, however, the study also found that unincorporated businesses created by unemployed people in states with higher unemployment benefits seemed to be more successful according to both their survival rate and overall profitability. This suggests that higher benefits may act as a kind of screening device that filters out lower-quality businesses.
This phenomenon appeared to be especially pronounced during periods of recession, when potential entrepreneurs are perhaps the least optimistic about the prospects of their business.
“Since the disincentive effect resulting from the profit deduction requirement mainly concentrates on businesses with smaller profits, the effect will be larger when there are more businesses that expect to make smaller profits,” the researchers explain.
Poor prospects
Indeed, recessions appeared to make people three times less likely to become self-employed if unemployment insurance was strong. The authors believe their findings demonstrate the importance of ensuring that profits from any business activities aren’t deducted from unemployment benefits, as this would help to mitigate the negative effects and encourage unemployed people to start their own businesses.
Most self-employment assistance programs are designed to provide just this kind of incentive as they support people creating a business without either any profits being deducted from their support while also waiving any requirement for the individual to search for work.
As of 2016, the researchers found that just eight states had this kind of program, with restrictive conditions meaning that relatively few people were participating in them. The authors believe that if regions wish to encourage more entrepreneurship, then self-employment assistance programs can play a crucial role, especially if conditions are relaxed to ensure that more unemployed people qualify. This is especially important during recessions when people are generally more pessimistic about their prospects.
“During the COVID-19 pandemic, the share of new entrepreneurs who were initially unemployed reached the highest level (30%) recorded in 25 years,” the authors conclude. “Hence, it becomes urgent and important for policymakers to remove obstacles and smooth such a transition.”
