Social insurance and entrepreneurship: The effect of unemployment benefits on new‐business formation

Abstract

AbstractResearch SummaryThis article studies the impacts of social insurance on the decisions of unemployed individuals to start businesses. Exploiting staggered changes in benefit generosity across U.S. states and over time, I find that higher unemployment insurance (UI) benefits both lower the probability that an unemployed person will become self‐employed, and also extend the length of time that passes before they make such a transition. The negative effects of UI benefits are concentrated on the formation of unincorporated businesses. Unincorporated businesses created by unemployed people in higher‐benefit state‐periods tend to be more successful, as measured by profit and survival rate, suggesting that higher benefits mainly screen out the entry of less productive firms. The negative effects are smaller during nonrecession periods and in states that offer a Self‐Employment Assistance program.Managerial SummaryDuring the COVID‐19 pandemic, the share of new entrepreneurs who were initially unemployed reached the highest level (30%) recorded in 25 years. This article studies factors that impact the decision of unemployed people to start businesses. My empirical results show that higher unemployment insurance (UI) benefits deter unemployed people from forming unincorporated businesses, while those that do enter the marketplace perform better than others located in lower‐benefit state‐periods. These results suggest that higher UI benefits mainly screen out lower‐quality businesses due to the requirement that business profits have to be deducted from UI benefits. The disincentive effects are larger in states without Self‐Employment Assistance (SEA) program and during recessions, suggesting the need for widespread policies like the SEA program, especially during economic downturns.