Unemployment in the UK rose to 4.3% at the end of March 2024. While not alarmingly high, this is the highest rate since September 2021, during the second year of the COVID pandemic, when it reached 4.4%.

Higher interest rates, designed to curb spending and boost saving, may push unemployment higher. With borrowing becoming more costly, businesses might struggle to finance investments and production, leading to cost-cutting measures, including layoffs.

The well-known solution to job creation is entrepreneurship. New businesses stimulate the economy through investments and employee salaries. However, higher interest rates make borrowing more expensive, which can stifle new business ventures. Additionally, rising unemployment means less disposable income for consumers, impacting potential revenue for these startups.

How can we ensure sufficient economic liquidity for new businesses to thrive, despite higher borrowing costs and reduced consumer spending?

The OECD suggests that unemployment benefits can help. These payments support consumer spending while individuals search for new jobs, thus sustaining businesses. Besides providing a humanitarian safety net, unemployment benefits can help maintain economic stability.

Complex link

However, recent research from the University of Galway reveals a complex relationship between unemployment benefits and entrepreneurship. Analyzing over 500 European regions from 2008 to 2019, the study found that increased national spending on unemployment benefits was associated with decreased rates of business creation, even when accounting for GDP fluctuations, population changes, business closures, foreign investment, and taxation.

Why might this be the case? Paradoxically, unemployment can drive necessity-based entrepreneurship, where individuals start their own businesses to escape joblessness. Generous unemployment benefits might reduce this motivation, as people are less pressured to create their own jobs. Consequently, higher spending on unemployment benefits could correlate with lower business creation rates.

But there’s more to the story. Businesses born from necessity-based entrepreneurship often have higher failure rates. Traditionally, successful entrepreneurs spot a market gap and pursue it, sacrificing steady employment for a promising opportunity. In contrast, necessity-based businesses are often launched without a viable economic or passionate motivation, leading to poorly performing firms with weak strategies.

Low performing businesses

Thus, while necessity-based entrepreneurship increases the number of businesses, it doesn’t necessarily boost high-performing companies. Additionally, large unemployment benefit expenditures might fund back-to-work schemes alongside out-of-work benefits. These schemes aim to improve employability, reducing the need for necessity-based entrepreneurship by helping people find jobs more easily.

This negative correlation between unemployment benefits and entrepreneurship underscores the complex trade-offs policymakers face. Unemployment benefits are crucial both economically and humanitarily, preserving consumer demand during economic shocks and providing a safety net. However, the potential downside of lower business creation is a trade-off governments must navigate carefully.

Ultimately, investing in unemployment benefits to fund back-to-work schemes might be more beneficial. These programs can steer people back into the job market, mitigating the risks associated with necessity-based entrepreneurship. In this case, the negative relationship between unemployment benefits and entrepreneurship may not be as harmful to the economy as it appears.