Effects of the Economic Recession on UK Entrepreneurship

Before proceeding it is important to explain what an economic recession is and clarify the point at which the recession officially hit the UK.

The National Bureau of Economic Research (NBER) define a recession as “ a significant decline in activity spread across the economy, lasting more than a few months, visible in industrial production, employment, real income, and wholesale and retail trade”. Many professionals and experts around the world believe that a true economic recession can only be confirmed if GDP (Gross Domestic Product) growth is negative for a period of two or more consecutive quarters (Recession.Org).

According to the Office for National Statistics, GDP is formed by three activities namely; Output, Income and Expenditure. From the output or production approach – GDP measures the sum of the value added created through the production of goods and services within the economy. GDP from the income approach measures the total income generated by the production of goods and services within the economy. Lastly, GDP from the expenditure approach measures the total expenditures on all finished goods and services produced within the economy. When comparing what GDP is composed of and the NBER definition of an economic recession, it can be seen that the areas it explains the decline occurs in all fall under GDP. Therefore it may be said that an economic recession is a significant decline in GDP lasting more than a few months. This NBER definition gives an idea of what a recession is in terms of its effects on the economy. However, the phrase ‘more than a few months’ may require some clarity. In the FRBSF Economic Letter, the timescale was given to be more than two quarters, that is, six months. According to Andrew Sentance (2008) an external member of the Monetary Policy Committee of the Bank of England, in a Bank of England conference accepts that the accepted definition of a recession occurs when a country experiences a fall in Gross Domestic Product (GDP) for at least two quarters in succession, but further explained that he personally refers to a recession as a fall in GDP “year-on-year.” Whichever the case may be, there is a clear consensus that a recession is when an economy experiences a fall or decline in GDP for at least two quarters.

In order to clarify when the UK began to experience a recession, this paper uses a graph published by the ONS (Fig A above). It shows the quarterly GDP of the UK from 2006 till 2010. When looking at the diagram, it can be seen that the UK experiences consecutive fall in GDP for at least two quarters from the second quarter of 2007. This carries on till the first quarter of 2009. Based on the definitions of the recession above, this ‘ticks all boxes’ as the sign of the kind not only lasts for longer than two quarters but carried on year-on-year. It can therefore be said that the UK began to experience an economic recession from the second quarter of 2007 and lasted till the first quarter of 2009. After the first quarter in 2009, although still in deficit, the UK experiences a growth in GDP.

Numerous studies and research have been carried out over the years, to improve on the understanding of entrepreneurial behaviour and have ultimately added to the increasing body of research of entrepreneurship. In this section, some of these studies will be briefly discussed while the more pertinent cases will be covered in depth. This paper aims to contribute to the discussion about the nature of entrepreneurial behaviour, specifically, during an economic recession and within rural regions. To do this, it focuses mainly on unemployment because it is an almost guaranteed economic reaction to a recession. This paper investigates regional variations because if in reality regions are structured differently, then surely they should in theory react differently. Since entrepreneurial activity has been previously through research linked to unemployment, then perhaps entrepreneurial activity across UK regions should be looked at as a possibility to the regional variation.

Entrepreneurial Activity

According to Schumpeter, entrepreneurs resemble waves of innovation from his book ‘gales of creative destruction.’ The innovative activity is likely to have two impacts; they propel the economy out of recession and, because they induce structural change in otherwise stagnant markets, they stimulate long-run growth (perhaps it may be said that whether in a recession or not, entrepreneurial activity and growth is critical to economic development and economic bailouts). Maybe what Schumpeter was also implying is that the reason why they are important is because they are rarely affected by the economic situation because they are innovators in their own rights by not just identifying opportunity but also creating it.

Entrepreneurs achieve and maintain success through identifying opportunities and taking risks because it is what defines them. Identifying and selecting right opportunities for new businesses are among the most important abilities of a successful entrepreneur (Stevenson et al., 1985). Consequently, explaining the discovery and development of opportunities is a key part of entrepreneurship research (Venkataraman, 1997). Entrepreneurs identify business opportunities to create and deliver value for stakeholders in prospective ventures. While elements of opportunities may be ‘‘recognized,” opportunities are made, not found. Hisrich 1986, mentions accepting risk as one of the characteristics of entrepreneurship; Herber & Link also support this by explaining that ‘entrepreneurship pertains to a risk taker, a creative venture…’ “By definition entrepreneurship requires making investments (time, effort, and money) today without knowing what the distribution of the returns will be tomorrow” (Venkataraman1997). There is a fundamental uncertainty that cannot be insured against or diversified away (Knight, 1921). It is also of their nature to identify opportunities and as a result seize them. “Entrepreneurs may not think of themselves as being any more likely to take risks than other entrepreneurs, but they are nonetheless predisposed to cognitively categorize business situations more positively. This interpretation leads entrepreneurs to view some situations as “opportunities,” even though others perceive them to have little potential (i.e., the latter view these situations as risky ventures that offer disproportionately low returns relative to their associated risks)” (Palich & Bagby 1995).

Rampini 2000

His paper analyses a model in which the risk associated with entrepreneurial activity implies that the amount of such activity is procyclical and results in both amplification and intertemporal propagation of productivity shocks. In his paper, he suggests that individuals are risk averse agents choose between a riskless project and a risky project with higher expected return, an act which he terms ‘the entrepreneurial activity’. His perspective of entrepreneurial activity is that those who choose the entrepreneurial activity need to bear part of the project-specific risk for incentive reasons. An agent becomes an entrepreneur when productivity is high, because agents are more willing to bear risk and eventually bear less risk for incentive reasons. What he implies through his statement is that individuals are motivated to engage in entrepreneurial activity due to high productivity level of an economy. He argues that entrepreneurial activity is procyclical due to the risk associated with it, which possibly implies both considerable amplification and intertemporal widespread of productivity shocks. In other words high productivity creates motivation to become entrepreneurs, while it may be demotivating when productivity is low (recession) and reduce the number of agents who engage in entrepreneurial activity. Rampini explains that when productivity is high, agents are not only willing to bear more risk but also able to share larger fraction of that risk with outsiders. Therefore the extent to which project-risk is insurable corresponds positively with aggregates and makes entrepreneurial activity relatively more attractive in an economic boom than in a recession. He finishes off by suggesting that economies with higher productivity are better able to share specific risk and hence have more entrepreneurial activity.

R.Thurik (2003)

R. Thurik in 2003 also carried out another study to investigate the relationship (if any) between unemployment and entrepreneurship in the UK. In contrast to Rampini (2000), Thurik’s research seeks countercyclical evidence. The research question of his project was to investigate to what extent entrepreneurship (business ownership) can reduce the level of employment. They suggest that there is an ever evident shift from a managerial to an entrepreneurial economy (Audretsch and Thurik 2000). For example, the emergences of new industries like the software and biotechnology industries, where small firms play a critical role. The managerial economy had succeeded for nearly three quarters of the century and the latter the last quarter, suggesting transition is still incomplete. Thurik (2003) further explains that there is a change of the industry structure shifting to one where there is an increased role of small firms. But the timing of this shift varies across countries because as it is heterogeneous and depend on country-specific factors. These factors include institutions and policies. In support of this, Acs and Audretsch (1987) suggested that small firms have a relative advantage over their larger counterparts in highly innovative industries. Cultural differences also play an important role in the shift. According to Audrestch and Thurik (2000) there is an alternative to firm downsizing in order to preserve company life; knowledge. Audretsch and Thurik (2000, 2001) explain that the managed economy was driven by economic activity based on labour and capital, while the knowledge was the main characteristic of the entrepreneurial economy where comparative advantage is based on innovative activity, where it seeks and benefits from disequilibrium. On the other hand, under the managed economy, the policy to reduce unemployment lied in the cost of lower wages. However, Thurik (2003) clarifies that in an entrepreneurial economy; high employment can be combined with high wages, just as low wages do not necessarily imply high employment. He supported this by explaining that there was still a large variance in unemployment rates in spite of the widespread corporate downsizing throughout OECD countries. He suggested that there was a growing theoretical and empirical evidence that entrepreneurial economies are more successful at creating jobs to compensate for job lost to corporate downsizing (Carree and Thurik 2003). Smaller firms also attract employment from individuals in paid-employments because growth of small firms may suggest not only increased employment but also higher wages (perhaps the growth of new firms leads to hierarchies and increased wages) He therefore posed the question that if there has been a shift from a managed economy to an entrepreneurial one, and entrepreneurial activity evidently fosters economic growth, would an increase in entrepreneurship reduce unemployment? By using a two-equation model where a change in unemployment and in the numbers of business owners, Thurik compares development is both entrepreneurial activity and unemployment in the UK. He found that the contribution of UK entrepreneurial activity to reducing UK unemployment was less than other OECD countries. He concluded that the support structure for small and new business in the UK was up to par, however entrepreneurial activity was still at a low and attributed this revelation to the culture, attitude, education, finance and regulation of the UK. However, Thurik and Keollinger’s (2009) study on entrepreneurship and the business cycle may suggest that UK residents are now taking advantage of the support structure put in place.

Entrepreneurship and SMEs are related but certainly not identical concepts. Entrepreneurs, for example, are the

main drivers of the firm creation process where young and small firms play a role. On the other hand, the entrepreneurial energy of a country, region or industry is often described using phenomena such as firm creation and turbulence (Carree and Thurik, 2003). The role of entrepreneurship has changed dramatically, fundamentally shifting between what Audretsch and Thurik (2001) introduced as the model of the managed economy and that of the entrepreneurial economy. In particular, Audretsch and Thurik (2001) argue that the model of the managed economy is the political, social and economic response to an economy dictated by the forces of large-scale production, reflecting the predominance of the production factors of capital and (unskilled) labour as the sources of competitive advantage. By contrast, the model of the entrepreneurial economy is the political, social and economic response to an economy dictated not just by the dominance of the production factor of knowledge but also by a very different, but complementary, factor they had overlooked: entrepreneurship capital, or the capacity to engage in and generate entrepreneurial activity. It is not simply that knowledge or R&D always spills over due to its mere existence (Audretsch and Keilbach, 2003).

Suggest the degree of spatially specific entrepreneurship capital is shaped by regional-specific factors reflecting both entrepreneurial opportunities and the entrepreneurial capabilities

(P.D. Koellinger & A.R. Thurik 2009)

The objective of this project was to study the cyclical pattern of entrepreneurial activity i.e. it would confirm or challenge the idea that entrepreneurial activity was procyclical. They suggest that entrepreneurs have an essential role in explaining business cycle dynamics, and more specifically, it suggests that entrepreneurs play an important part in recovering from economic recessions. Concentrating on the 22 Organisation for Economic Co-operation and Development (OECD) countries as its sample, a balanced country panel was created for the period 1972-2007. Using ‘business ownership’ as a measure of entrepreneurial activity which includes incorporated self-employed (owner-managers of incorporated businesses) and self-employed with and without employees but excludes unpaid family workers and comparing this to annual real Growth Domestic Product (GDP) based on their average deviation for that period. They found that business-ownership rate preceded economic recessions and booms from 1972-2006. They also investigated the possibility of a relationship between unemployment and business ownership. Results showed that unemployment led the business-ownership cycle by 1 or 2years, which meant that increasing levels of unemployment were followed by a rise in business ownership. In addition, they measured correlations and found results to be close to (-1) which suggested countercyclicality. In order to add to the richness of their research they included another data source of entrepreneurial activity; the Global Entrepreneurial Monitor (GEM) data source. As mentioned earlier, the GEM data is known as the largest single study of entrepreneurial activity in the world. It is very reliable with numerous previous studies using it as a data source for entrepreneurial data, and uses at least 2,000 adult-age individual in each of the participating countries (Thurik and Keollinger 2009 citing Reynolds et al 2005). Focusing on nascent entrepreneurs i.e. “someone who has, during 12months preceding survey, done something tangible to start a new firm; who expects to own at least part of his new firm and who has not paid wages for more than three months” Thurik and Keollinger compared cyclical time patterns of real GDP with nascent entrepreneurial activity. They found that opportunity entrepreneurship led the business cycle by two, while necessity entrepreneurship led the cycle by only one year and exhibits some mildly pro-cyclic features tended to rise in response to a lack of employment alternatives in economic recession.

They concluded that entrepreneurs may create positive productivity shocks and innovations that give an impulse to the economy adding that there had been recognition of the connection between the labour market, entrepreneurial behaviour and the business cycle. Furthermore, it rejected two hypotheses that (a) the share of entrepreneurs in the population is independent from the cycle and (b) the share of entrepreneurs is procyclical and suggest otherwise.

When comparing the three studies above, it can be seen that there are two sides; namely the procyclical ‘camp’ and the countercyclical ‘camp’. With Rampini’s work falling under the former, Thurik and Thurik and Keollinger’s research falls under the latter.

Thurik (2003) and Thurik & Keollinger (2009) suggest that entrepreneurial activity is procyclical. Both findings are consistent in terms of the relationship between unemployment and entrepreneurial activity. Although Thurk and Keollinger differs from Thurik 2003 in that it looks at a longer period of time (1972-2007 compared to 1974-1998), Thurik and Keollinger’s findings acts as a reinforce of the idea that entrepreneurial activity is countercyclical and plays a critical part in unemployment reduction which Thurik 2003 had laid out. The strength of both studies can be explained as follows:

Unemployment is a result of an economic recession (Thurik’s 2003 looked at entrepreneurship and unemployment)

An economic recession is a part of the business cycle (Thurik and Keollinger 2009 looked at entrepreneurship and the business cycle)

Logically, both studies have entrepreneurship and an economic recession in common.

Thurik and Koellinger’s work also overlaps Thurik’s (2003) time period which was being focused on.

The fact that Thurik and Koellinger (2009) realised similar findings with Thurik 2003 not only strengthens it in terms of validity and reliability.

If Thurik, Koellinger and all other previous studies that suggested that entrepreneurship is countercyclical is valid and reliable, then it may be a finding in the analysis which will be carried out in section ?? The analysis to be carried out in section ?? will look at how entrepreneurial activity (business start-ups) fared during the economic recession. It will therefore give an account on entrepreneurial activity and unemployment. While is important to mention that both studies cover economic recessions that occurred in the 20th century and not of the 21st (‘the credit crunch’). This therefore creates a gap this paper hopes to fill. The result of the analysis should in theory fall under one of the two camps described earlier.

Regional Differences

In terms of regional dimensions, entrepreneurship has also been researched. Studies have looked to find out if and why there are entrepreneurial activity variations across UK regions. Entrepreneurship is the process of identifying and pursuing new opportunities is considered playing a vital role in innovation. This is done primarily by young and small firms who introduce breakthroughs and new products, whereas larger incumbent firms are rather involved in top routine large-scale processes of innovation (Audtretsch and Keilbach 2006 citing Baumol 1968, 2000). In other words, entrepreneurs are more flexible.

In this light, entrepreneurs play a vital function in the process of knowledge spillovers , and this arguably occurs in regional systems of innovation. Given that the aftermath of a new product idea or the possibility of a new technology being an economic success is uncertain, not all the new economic technology is used by incumbent firms as is supposed by the endogenous growth theory (Audretsch & Kilbeich 2006). If an entrepreneur believes that the benefits exceed what he gains as paid-employee, he will engage into starting up a new venture to realise the perceived benefits.(Audretsch & Kilbeich 2006). By doing so, he explores new knowledge that otherwise would remain unexplored, he thus is part of the knowledge spillover process in the economy. Audretsch, Kailbach and Lehmann (2006) denote this process as the ‘knowledge spillover theory of entrepreneurship’. This therefore implies that some regions may have that economic and technological new knowledge and therefore environmentally conducive for entrepreneurial activity while some others may be lagging behind.

Hart & Harrison 1983

In the quest to shed more light into entrepreneurial activity and regional development, this paper looked to find out the macroeconomic factors that influenced new small business formation in Northern Ireland. That is, those macroeconomic decisions that influenced the decision to pursue entrepreneurial activity in Northern Ireland. Using company registration data during the period 1951-1980, it reaffirms that there may be ‘push’ and ‘pull’ factors that influence new business formation. Push factor being what encourages an individual to leave paid employment which is mostly caused by the threat of unemployment. Pull on the other hand, makes self-employment look more attractive or profitable due to perceived economic performance. Using Schumpeterian theory, Hart et al explained that push factors lead to necessity entrepreneurship, in other words, individuals deemed it necessary to start their own businesses in order to ‘make ends meet’ temporarily due to unemployment. This paper provided analysis by looking at the how individuals transferred from paid-employment to self-employment by considering subjective assessment. They explain that individuals venture into new firm formation usually as a result of ‘naive optimism of inexperience’ (Citing Beesley; 1955).

Quoting Oxenfeldt (1943) the paper adds light into these subjective reasons, suggesting that there are 3distinguishable reasons why small firms. Firstly, individuals who as a result of gift, accumulation, inheritance or loan become financially able to start up their own businesses in order to meet with social and income status desires. Secondly, a deterioration of their paid-employment or of their perceived future acts as a source of motivation. Thirdly, the discovery of more attractive opportunities in starting new business induces individuals to leave their paid jobs. Hart et al explain that the subjective side is mainly fed be the feel of the individual to ‘be their own boss’ and to be independent. They further indicated two factors of increased entrepreneurial activity. First, there is empirical evidence that suggests that unemployment and the threat of unemployment are critical elements in new-firm formation. Second, an increase in unemployment creates a perception of instability and insecurity in an individual’s paid employment and consequently feeds the desire to be in control of their future by starting their own small business. An inference was therefore put forward, suggesting that the transition into self-employment, as a response to uncertainty and threat will become increasingly likely as recession intensifies. In the same light, the ‘pull’ factor will be more powerful when market conditions are perceived as promising consequently leading to a move into self-employment. This was proven by a noticeable increase in incorporated company registration in Northern Ireland in 1945 onwards. Although this paper may be criticized to be outdated, it is not to be ignored as it is pertinent to the area of study of this paper and is in fact important to use as a point of reference because it may shed more light into entrepreneurial activity by indicating what has changed and what still remains important.

Ashcroft, Love and Malloy (1991)

This was a study carried out on Scotland (mainly) with the aim of inputting to the topic of regional variation and new firm formation. Using VAT registrations data as an indicator of new firm formation, they found a few discoveries which as follows. (1) New firm formations differ noticeably across UK regions. (2) Scotland performed particularly poorly at both levels of spatial disaggregation, a fact which is not accounted for by an unfavourable industrial structure. (3)Scotland ranked highly in terms of entrepreneurial potential but not as high on performance- a situation they noticed with Wales also. (4) There was a positive correlation between firm formation and wealth, the expected income forgone by the entrepreneur and the entrepreneur’s probability of attaining this income and relevant entrepreneurial skills in the population. (5)Scotland and the North of England, suffer from a ‘deficiency of enterprise’ as measure by firm formation rates. In addition, enterprise agencies may have a significant role in encouraging new firm formation. This suggests that spillover entrepreneurship may support this finding. Entrepreneurship as a behaviour involves identifying and pursuing new opportunities. (Baumol 1968, 2000) suggested young and small firms are responsible for introducing innovation by introducing breakthroughs and new products. On the other hand, larger incumbent firms tend to be inflexible because they are routine-based, thus more engaged in process innovation. In respect, they play an important function in the process of knowledge spillovers , hence in any local system of innovation. Given that the outcome of a new product idea or the economic potential of a new technology is uncertain, not all the new economic technology is used by incumbent firms as is supposed by the endogenous growth theory. Entrepreneurs are agents who develop a vision about ne w possibilities based on new technological knowledge. If the entrepreneur guesses that the return he gains from the product are superior to that he gains as an employee, he will engage into starting up a new venture to realize his vision. By doing so, he explores new knowledge that otherwise would remain unexplored, he thus is part of the knowledge spillover process in the economy(Audretsch, Kailbach and Lehmann 2006) denote this process as the knowledge spillover theory of entrepreneurship. This statement suggests that some regions may have relatively more economic and technological new knowledge and thus environmentally more conducive for entrepreneurial activities while some others may be lagging behind, thus a plausible explanation for regional variation. The fact that some regions lack concentration of large firms in them may play a role in entrepreneurial activity regionally. If this is the case, it may mean that the entrepreurial behaviour may somewhat depend on the concentration of larger firms in its regions. (6)There was a role played by wage rate. The annual wage rate per employee was found to be negatively related correlated to firm formation, thus, implying that a regional differentiation in wage rate can contribute positively to new firm formation. (7) Finally and most importantly, new firm formation rate is primarily affected by certain dimensions of the economic and social structure of the region concerned. In respect to Scotland, it performed poorly compared with much of the rest of Britain because it had a low level of wealth (home ownership), a socioeconomic structure which is under-represented by education and in managerial and professional skills.

Keeble and Walker (1994)

In the same spirit, Keeble et al added to the pool of knowledge of entrepreneurial activity and regional variation. Their aim was to identify the most important influences underpinning spatial variation in new firm formation, growth numbers of small business and firm dissolution in the UK during the 1980s. In their exploration of small business growth, they realised that small business growth is consistently and very strongly related to previous local population growth and to capital availability measured by housing wealth. In respect to new firm formation (on the demand side), they explained that previous growth of income or GDP and local population changes were determinants. On the supply side, population change, capital availability firm size and sector structures and growth in unemployment were key factors to new firm formation.

Although this may not concern this section of the literary review as it focuses on entrepreneurial activity and regional variations, it is pertinent to this paper, and cannot be ignored, that Keeble et al found a growth in unemployment to fuel new firm formation (entrepreneurial activity). Although the other determinants to new business start-up mentioned above are equally as important, this particular finding is critical to the previous section of the literature review. This is because it is consistent with Thurik’s (2003) inference that an increase in entrepreneurial activity reduces unemployment – this adds to its reliability.

In conclusion, Keeble at al found that for new firm formation, the most important factors that determined the regional variation were local population growth, capital availability as indicated by housing wealth and professional and managerial expertise.

Robson (1998)

In his paper, attempted to make an account for significant regional variations that existed in both the occurrence and growth rate of self-employment and attempts gain some clarity in regards to the determinants of the rise in aggregate self-employment. It provided an analysis of pooled cross-section time-series data on male self-employment in the eleven standard regions of the UK during the period 1973-1993. Its theoretical framework focused on ‘the relative returns of self-employment’ and ‘the ease with which start-up finance may be obtained.’ These two factors could arguably vary regionally and could provide a perspective to the pool of research that looks into entrepreneurial activity varying across regions. In light of the first part of the framework, Robson considers the fact the macroeconomic setup of the different regions may vary and may as a result influence the relative returns of self-employment. For example, real GDP per capita of a region may be higher than another and a result mean that if can sustain a relatively larger number of niche market which may serve as an opportunity for small businesses set up and survival. In addition, he considers that not all individuals are equally endowed with entrepreneurial skills necessary to succeed in self-employment. This therefore acts as a determinant of the regional variations, i.e. rates of self-employment will therefore also depend on the extent to which members of the regional labour force are suited to successful venture into an entrepreneurial career. He further adds that regional rate of male self-employment is expected to be negatively related to the regional level of average earnings. In regards to unemployment and self-employment, he adds that the decision to enter or remain in self-employment will be the ease with which alternative employment may be obtained. If opportunities for paid work are relatively scarce, self-employment may be the only viable option for many of those wishing to avoid, or escape from, the experience for unemployment. This view is in accordance with previously formulated rationale behind the rise in new business formation in the UK during the 1980s which suggests that at given wage rates, self-employment will be relatively high in those regions in which opportunities for paid employment are relatively scarce (that is, a recession-push). Robson finally suggested that relative returns of self-employment rate will be influenced by the prevailing rate of self-employment.

In light of the latter part of the framework, that is, the ease with which start-up finance may be obtained, Robson gives two aspects; the amount of finance needed for start-up, and the ease with which the finance is obtained. The former depending on the intended industry to be entered, he explained that a lower level of finance would be expected in industries characterized by a relatively low minimum efficient scale of operation- a reason why self-employment rates are much higher in some industries than others. The industries with the highest rate of males self-employment include; Constru