During the COVID-19 shock, many policies towards firms were directed to support incumbents. Still, little was done to support the creation of new businesses, representing an obstacle to growth recovery in the short and medium run. In BSE Working Paper 1377, “Income Inequality and Entrepreneurship: Lessons from the 2020 COVID-19 Recession,” Christoph Albert, Andrea Caggese, Beatriz González, and Victor Martin-Sanchez study the impact of the pandemic and the subsequent recession on new businesses’ dynamics using survey data for Spain.
The COVID-19 shock greatly affected the creation of new businesses
The authors use data from the Global Entrepreneurship Monitor (henceforth GEM) for Spain, which has been running as a repeated cross-sectional study since 1999. This survey allows for comparisons with the Great Financial Crisis of the late 2000s and to have data on entrepreneurial efforts occurring during the pandemic.
The COVID-19 crisis significantly impacted the creation of new businesses. Among the respondents in the GEM that were involved in entrepreneurial activity in 2020, nearly 60% strongly agreed that the pandemic caused a delay in getting the new business operational. Further, the authors find that this crisis not only decreased the total number of new firms being created but also changed the composition of new entrants, with the pandemic making it less likely for high-growth firms to enter the market.
While data shows that the overall probability of starting a new firm dropped to levels comparable to those seen during the Great Financial Crisis (Figure 1), the impact depending on household income is strikingly different.
Low- and middle-income entrepreneurs’ firms are the most affected ones
The pandemic impacted entrepreneurs differently, both in subjective and objective measures, as suggested in Figure 2. The authors’ analysis confirms that it is mainly income inequality, as opposed to other characteristics such as education or age, which is driving this heterogeneity.
Figure 2 shows that nearly 75% of low-income individuals surveyed stated that starting a new business in 2020 was more difficult than during the previous year, in contrast to only 60% of high-income saying so. Entrepreneurs of lower income were also more likely to claim that COVID-19 offered less opportunity to exploit while also expecting lower growth.
Moreover, the drop in firm entry during the 2020 crisis, shown above in Figure 1, is mainly concentrated among low- and middle-income households. The probability of starting a new firm for high-income households was mainly unchanged, while the share of high-growth firms for this income group increased. This is at odds with what we saw during the 2008-2010 crisis when firm creation fell more among high-income households.
Differences in financing sources are crucial in explaining this heterogeneity
Multiple factors may explain these diverging patterns. One reason may be that the COVID-19 crisis induced more entrepreneurs to create a firm out of necessity rather than for intrinsic motivation, given that these are more likely to be low-growth firms.
However, the authors find no evidence of this behavior. Instead their analysis show that it was the easier access to alternative finance sources for high-income entrepreneurs that caused this wedge. In the presence of more significant financial constraints, high-income households could exploit better new opportunities due to larger wealth and better access to external financing.
In comparison, the decline in new firm creation was larger among high-income households during the Great Financial Crisis, which could be explained by the sudden drop in real estate values affecting the leverage capacity of wealthier households.
The policy should not neglect financing constraints of potential entrants
The authors highlight that these findings show the importance of constraints on access to finance for low-income households in explaining the heterogeneous patterns in new businesses’ dynamics during the pandemic. More importantly, their findings indicate that policymakers should consider the design of measures to alleviate credit constraints of potential entrants, especially for low-income households, to support a durable recovery after a shock that disproportionately affected entrepreneurs at the low end of the income distribution.