The Effect of Economic Crisis on Entrepreneurship - Research Paper Example

The Effect of Economic Crisis on Entrepreneurship Table of Contents Introduction 1 A.Structure for the Research 1 B.Statement of the Research Topic, Research Question and Research Objectives 2 C.Explanation of Research Methodology 2 D.Discussion of the Main Findings 2 Research Methodology 3 A.Data Collection 3 B.Data Analysis 3 Presentation and Discussion of Research Findings 3 A.Entrepreneurship and Economic Growth 3 B. Brief Overview of the 2008 Economic Crisis 6 C.Relevant Statistics on Entrepreneurial Activities during the Economic Crisis 7 D.Analysis of Findings 12 Conclusion 14 A.Summary of Main Points of Arguments 14 B. Answers to the Research Questions 14 C.Outstanding Issues for Further Research 16 Reference List 17 The Effect of Economic Crisis on Entrepreneurship Introduction The economic crisis that besieged the United States in the year 2008 has impacted a wide range of organizations spanning both domestic and international sectors. The number and stability of business establishments opened and maintained which are perceived to be closely related to the economic status of a nation is hereby to be examined. The current research would delve into potential impact of the recent economic and financial difficulties that affected various countries worldwide. The focus would be on the recent recession that impacted the United States economy and determining how these economic factors affected the rate new businesses are established or current businesses opted to close or declare bankruptcy. Although business management courses have included various course modules on entrepreneurship that focus on strategies that would assist in establishing new businesses or determining factors and traits of successful entrepreneurs, information on the effect of economic crisis to entrepreneurship is not vagrantly published. The current discourse would closely examine whether the economic crisis detracts potentially talented entrepreneurs from establishing new business endeavors or lead successfully established businesses into financial loss and bankruptcy. The statistics that could be searched would provide the theoretical framework for the research. Likewise, interpretation of the statistics and numbers of new or closed businesses during the period of economic crisis would assist aspiring entrepreneurs in learning from the experiences of others. A. Structure for the Research The research would explicitly define the statement of the research topic, the research questions and objectives in the next section; prior to expounding on the research methodology and an abstract of the findings of the study. The presentation and discussion section would be divided into initially presenting the link between entrepreneurship and economic growth; a brief overview of the economic crisis of 2008; exhibiting the relevant statistics on business establishments that were affected by the economic crisis and analyzing the information revealed from these statistical figures. The concluding portion would summarize highlights of the research and note some limitations and implications for current and future research. B. Statement of the Research Topic, Research Question and Research Objectives The research aims to determine how the economic crisis affect and impact entrepreneurship in the United States. The objective could be achieved through addressing the following research questions: • In the recent economic crisis, how many new businesses in the United States were recorded? How many existing businesses were closed or filed bankruptcy? • Aside from economic factors, were there other contributory factors that led to opening new businesses or closing existing ones? • What entrepreneurial theories were eminently applied during economic crisis to ensure survival? C. Explanation of Research Methodology A description and qualitative research method would be proposed for the current research. Secondary sources of authoritative and academic information would provide support to contentions and would validate results, as required. From current statistics, relevant findings would be interpreted and would form the basis for recommendations and conclusions. D. Discussion of the Main Findings The main findings revealed that business births decline and closures, as well as bankruptcies increase during the 2008 economic crisis. The factors that were contributory to this trend were the tight financial credit and access to loans, lower consumer spending, and cost of federal regulations. In order to survive and sustain continued operations, using “Drucker’s perspective that firms seeking to survive in turbulent times should (a) focus upon adopting entrepreneurial innovative solutions to sustain business performance and (b) recognise the importance of strategic flexibility” (Chaston, n.d., p. 2), organizations need to focus on their core competencies, streamline existing operations, minimize costs, and be creative and innovative in proposing solutions to challenging situations. Research Methodology The research employed the secondary method consisting of closely examining primary and secondary research that has already been conducted on the subject by other professionals or authorities in this field of endeavor. The method of data collection and data analysis are hereby expounded in greater detail: A. Data Collection The current research would adopt a structured literature review. By using diverse authoritative materials on the subject of the effects of the economic crisis on entrepreneurship, the study initially focused on the key terms such as: link between entrepreneurship and economic status or growth; statistics of business establishment during economic crisis; entrepreneurship and recession. B. Data Analysis The selection of articles used the key terms as abovementioned and synthesized the data according to the information deemed crucial to address the identified research questions. The research method used a review of related literature and critically analyzed the information qualitatively. Some facets of quantitative analysis is proposed to be used when interpreting statistics on the number of business establishments opened and closed during the period under review. Presentation and Discussion of Research Findings A. Entrepreneurship and Economic Growth Entrepreneurship could be perceived as an intimidating term especially for business practitioners who understand the extent of challenges and influencing factors that make or break the prospective ventures. In the study conducted by Ahmad and Seymour (n.d.), the authors traced the developments and evolution of disparities in defining the term ‘entrepreneurs’ through citing as much as 14 researches on the topic and summarized as Table 1, below: Table 1 – A Review of Definitions of Entrepreneurs Essence of definition Publication Sources Entrepreneurs buy at certain prices in the present and sell at uncertain (Cantillon,1755/1931) prices in future. The entrepreneur is a bearer of uncertainty. Entrepreneurs are “projectors”. (Defoe, 1887/2001) Entrepreneurs attempt to predict and act upon change within markets. The entrepreneur (Knight, 1921) bears the uncertainty of market dynamics. The entrepreneur is the person who maintains immunity from control of rational (Weber, 1947) bureaucratic knowledge. The entrepreneur is the innovator who implements change within markets through the carrying out of new combinations. (Schumpeter, 1934) These can take several forms:  the introduction of a new good or quality thereof,  the introduction of a new method of production,  the opening of a new market,  the conquest of a new source of supply of new materials or parts, and  the carrying out of the new organisation of any industry. The entrepreneur is always a speculator. He deals with the uncertain conditions of the future. His success or failure depends on the (von Mises, 1949/1996) correctness of his anticipation of uncertain events. If he fails in his understanding of things to come he is doomed… The entrepreneur is coordinator and arbitrageur. (Walras, 1954) Entrepreneurial activity involves identifying opportunities within the economic system. (Penrose, 1959/1980) The entrepreneur recognises and acts upon profit opportunities, essentially an arbitraguer (Kirzner, 1973) Entrepreneurship is the act of innovation involving endowing existing resources with new wealth-producing capacity. (Drucker, 1985) The essential act of entrepreneurship is new entry. New entry can be accomplished by entering new or established markets with new or (Lumpkin & Dess, 1996) existing goods or services. New entry is the act of launching a new venture, either by a start-up firm, through an existing firm, or via „internal corporate venturing‟. The field of entrepreneurship involves the study of sources of opportunities; (Shane & Venkataraman, the processes of discovery, evaluation, and exploitation of opportunities; 2000) and the set of individuals who discover, evaluate, and exploit them. Entrepreneurship is a context dependent social process through which individuals and teams create wealth by bringing together unique packages (Ireland, Hitt, & Sirmon, of resources to exploit marketplace opportunities. 2003) Entrepreneurship is the mindset and process to create and develop (Commission of the economic activity by blending risk-taking, creativity and/or innovation European with sound management, within a new or an existing organisation. Communities, 2003) Source: Ahmad and Seymour n.d., p. 8 From these definitions, it could be deduced that entrepreneurs assume a proactive stance in capturing opportunities in the external environment (Penrose, 1959/1980; Kirzner, 1973; Shane & Venkataraman, 2000; Ireland, Hitt, & Sirmon, 2003) and bearing the risks of uncertainty (Cantillon,1755/1931; Knight, 1921/1942; von Mises, 1949/1996). Further, an entrepreneur was seen by Walras (1954) and Kirzner (1973) as arbitrageur, defined as “a type of investor who attempts to profit from price inefficiencies in the market by making simultaneous trades that offset each other and capturing risk-free profits” (Investopedia, 2012, par. 1). The amount and extent of expertise, business acumen and talent of entreprenuers must be highly competent to balance risk taking with opportunities taking using internal and external resources to make them a distinct and exemplary breed and to enable them to spur economic growth and development. Spurring economic activity was noted explicity and solely by the Commission of the European Communities (2003). In an article written by Dejardin (2000), the author disclosed that “an increase in the number of entrepreneurs leads to an increase in economic growth. This effect is a result of the concrete expression of their skills, and more precisely, their propensity to innovate” [Dej00]. The concepts linking entrepreneurship and economic growth were closely evaluated in an article written by Holcombe (1998) that provided the conceptual frameworks for establishing the link through a deeper understanding of the ideas of Adam Smith (1776) and David Ricardo (1821). Smithian theory was summed as disclosing that “the potential for economic growth was virtually unlimited, whereas Ricardo viewed the potential for economic growth as limited by the availability of economic resources” (Holcombe, 1998, p. 45). The discourse likewise presented two more theories: the growth theory and Kirzner’s theory of entrepreneurship, as encompassing and instrumental for economic growth: “the growth framework furthers Kizner’s model of entrepreneurship by helping to illustrate where entrepreneurial opportunities orginate, why more opportunities arise in some sectors of the economy than others, and what factors can provide incentives for entrepreneurs to more intensively search for new entrepreneurial insights” (Holcombe, 1998, p. 60). These studies have established a strong link between entrepreneurship in times of economic growth. The current study aims to delve into determining how entrepreneurs view economic recessions in terms of facilitating or hindering the establishment of new ventures or sustaining current entrepreneurial activities. The article written by Kedrowsky (2008) examined the “extent of a company company’s founding date—with a particular focus on company cohorts from weak economic periods—related to its eventual financial success” (p. 1). In this regard, the next section would provide a brief overview of the 2008 economic crisis which would provide the framework of examining the number of businesses that were established or closed during the period under study. B. Brief Overview of the 2008 Economic Crisis The cause of the economic crisis of 2008 was the over expansion of housing credits given to borrowers with predominantly poor credit ratings, without requiring any down payment and with approvals waiving the need for verification on assets or income to traditionally support financial loans. These loans were classified as ‘sub-prime’ loans, were more than 6% were reported to be in default in the U.S. [Dav08]. When asked why banks granted these risky loans, Davis (2008) disclosed that “the Clinton administration pressured the banks to help poor people become homeowners, a noble liberal idea. Also the Clinton Justice Department threatened banks with lawsuits and fines ($10,000 per application) for redlining (discrimination) if they did not make these loans. Also ACORN (Obama’s community service organization) was instrumental in providing borrowers and pressuring the banks to make these loans” (Davis, 2008, par. 5). As a consequence, the effects are summarized concisely by Igarashi, et al. (2008) as manifesting credit contractions; suppression of consumption expenditures in US households to repay existing debts; restricted fund raising environment; perceived hindrances to future business fixed investments; and economies seen to severely decline. Due to the restrictions in credit and funding during a recession, one could perceive that there would be natural tendencies for entrepreneurial ventures to decline and to manifest risk aversion and focusing on currently sustaining established businesses. The statistics below would reveal some interesting findings. C. Relevant Statistics on Entrepreneurial Activities during the Economic Crisis In an article written by Weitekamp and Pruitt (2010), relevant information regarding the number of entrepreneurial activities were closely monitored and the Kauffman Index of Entrepreneurial Activity, a leading indicator of new-business creation in the United States, revealed that “the number of new businesses created during the 2007–2009 recession years increased steadily year to year. In 2009, the 340 out of 100,000 adults who started businesses each month represent a 4 percent increase over 2008, or 27,000 more starts per month than in 2008 and 60,000 more starts per month than in 2007” (par. 2). The following figure (Figure 1) illustrates the rate of new business creation from the period 1996 to 2006. The rationale provided for the increase in business creation rate include seeing “challenging economic times (which) can serve as a motivational boost to individuals who have been laid-off to become their own employers and future job creators…Because entrepreneurs drive the economy, the growth in 2009 business startups is encouraging and hopefully points to a hopeful trend in terms of our economic recovery” (Weitekamp and Pruitt, 2010, par. 3). Figure 1A: Rate of New Business Creation, 1996 to 2009 Reprinted by: Weitekamp and Pruitt, 2010 The responses of unemployed individuals as seeking opportunities by opening entrepreneurial ventures were also studied by Fairlie (2011) who averred that “business ownership may provide an important alternative to unemployment for many individuals facing poor labor market conditions” (p. 25). In another study, authored by Fairlie (2010), the temporary increase in business creation during the recession which was supposedly triggered by the number of people who were displaced from jobs and were rendered unemployed has been termed ‘necessity’ entrepreneurship (p.1). On the contrary, in the article written by Shane (2011), the author dispelled Kauffman’s contentions and instead, revealed that “the Great Recession was actually a time of considerable decline in entrepreneurial activity in the United States” [Sha11]. As proof, the author indicated that there are diverse factors to be integrated in measuring entrepreneurial activity including self-employment, numbers on incorporated and unincorporated self-employment, the number of people who were reported to own and likewise operate a business, and the stock of employer firms ([Sha11]. From the Figure 1B, below, one could interpret that the net change in employer businesses significantly declined as a result of the 2008 economic crisis: Figure 1B: Net Change in Employer Businesses Reprinted by: Shane, The Great Recession’s Effect on Entrepreneurship 2011 Likewise, another relevant information that measured the net effect of the recession was the number of business establishments that closed. As indicated and reported by Shane, citing from the Small Business Administration (SBA), “68,490 more businesses closed in 2009 than in 2007, an 11.6 percent increase in the business closure rate. But in 2009, 115,795 fewer employer businesses were founded than in 2007, a 17.3 percent decline in firm formation. Moreover, the number of new employer firms started in 2009 was 553,000, the lowest number since 1992, according to the SBA. When the numbers are adjusted for population growth, this decline is even more severe, with the number of new employer firms decreasing from 2.2 per thousand people in 2007 to 1.8 per thousand people in 2009, the lowest per capita business formation rate since 1998” (Shane, The Great Recession’s Effect on Entrepreneurship, 2011, pars. 18 & 19). These figures are indicative of the negative impact of the economic crisis on entrepreneurial activity. From the data sourced from the Small Business Administration (SBA), the number of businesses opened and closed from the period 2005 to 2009, including the number of bankruptcies are shown as Table 2, below: Table 2: Starts and Closures of Employer Firms, 2005 to 2009 Starts and Closures of Employer Firms, 2005-2009 Category          2005            2006           2007           2008          2009      Births           644,122         670,058       668,395       626,400e    552,600e Closures       565,745         599,333       592,410       663,900e    660,900e            Bankruptcies 39,201           19,695         28,322          43,546        60,837 Notes: e = Advocacy estimate.Bankruptcies include nonemployer firms. Source: U.S. Dept. of Commerce, Census Bureau; Administrative Office of the U.S. Courts; U.S. Dept. of Labor, Business Employment Dynamics (BED). Estimates based on Census data and BED trends. Reprinted: Small Business Administration, n.d. From the tablular illustration, it could be deduced that the number of births decreased consistently since 2006 until 2009, with an average decline rate of 6.1% for the three-year period. The number of closures, on the other hand, exhibited an antithetical trend by manifesting consistent increases from the period 2005 to 2008. The average rate of increase in businesses closed from the comparative period 2006 to 2009 is 4.25%. Finally, the bankruptcies reported reflected a similar trend to the number of business closures, as the number of bankruptcies increase from 2006 to 2009 at a staggering average rate of 137.26%. In an article written by Vredeveld (2011), it was revealed that “more than 99 percent of the 27 million firms in the U.S. are small businesses, most of which are run by single proprietor” (p. G2). Therefore, small businesses are accurate representative of measuring entrepreneurial activity in the U.S., especially during the economic crisis. The other relevant statistics noted and gathered from identified sources are summed below, as Table 3: Table 3: Measures of Entrepreneurial Acitivities: the Great Recession, 2008 Measures Reported Pattern Source Index of total entrepreneurial activity: share of the adult-age population that is engaged in activities to set up new businesses declined from 9.6 percent in 2007 to 7.9 percent in 2009 Global Entrepreneurship Monitor Data on new private establishments: a combination of new firms and new outlets at existing businesses 218,000 to 176,000, a decline of 19.3 percent—20.8 percent Bureau of Labor Statistics Data in new incorporations on a global scale “nearly all countries experienced a sharp drop in business entry during the crisis” (Klapper & Love; cited by Shane, 2011) World Bank data Source: Shane, The Great Recession’s Effect on Entrepreneurship, 2011 D. Analysis of Findings From the gathered statistics, it was eminent that the economic crisis of 2008 actually contributed to a decline in entrepreneurial activity, as evidenced by the number of businesses opened and closed for the period under study. Likewise, the staggering number of bankruptcies also reflects the inability of businesses to sustain growth and survival especially in periods of economic downturn. The relevant factors that apparently contributed to the net decline in entrepreneurial activity are: available financing and federal regulation. According to the SBA, “the smallest firms (fewer than 20 employees) spend 36 percent more per employee than larger firms to comply with federal regulations. The disparity is greatest in two areas: very small firms spend four and a half times as much per employee to comply with environmental regulations and three times more per employee on tax compliance than their largest counterparts” (Small Business Administration, n.d., par. 10). Table 4 shows the annual cost of federal regulations by firm size: Table 4: Annual Cost of Federal Regulations by Firm Size Annual Cost of Federal Regulations by Firm size   Type of                           Cost per Employees for Firms with: Regulations             Fewer than                      20-499                500 or More                                20 Employees              Employees            Employees        All Regulations         $10,585                              $7,454                       $7,755 Economics                   4,120                               4,750                         5,835 Tax Compliance           1,584                                1,294                            883 Occupational Safety and Home- Land Security                  781                                   650                             520 Source: The Impact of Regulations Costs on Small Firms, an Advocacy-funded study by Nicole Crain and Mark Crain, 2010 (www.sba.gov/advo/research/rs371tot.pdf). Reprinted: Small Business Administration n.d. This fact therefore attests to the greater financial challenge posed by federal regulations on small businesses with fewer employees and therefore contribute to the increased numbers of business closures and bankruptcies, especially during the financial crisis of 2008. Likewise, as disclosed by Vredeveld (2011), the ability of small businesses and new entrepreneurial ventures to find financial through bank loans were considerably tight during the period. As emphasized, “finding financing also has been a real problem. For start-ups it is an uphill battle; banks, which are trying to improve the quality of their loan portfolio, are often reducing their loans and are reticent to take on the needs of start-ups” (p. G2). The disparity with the Kauffmann’s Index of Entrepreneurial Activity and that reported by the SBA was in fact explained by Shane was the incorporation of other factors and the integration of the number of business closures that generated and reflected a negative impact on entrepreneurial growth. Fairly (2010) initially shared the same results as published in the Kauffman report. Fairlie (2010) evaluated factors that contributed to the rise in entrepreneurial activities during recession. As averred, “slack labor market conditions are a key determinant of business creation. Although the corresponding declines in home ownership and housing equity in recessionary periods work in the opposite direction by decreasing access to financial capital they are not nearly as large as the counter-cyclical effects of local labor market conditions. The positive effects of individuals turning to self-employed business ownership because of the lack of better opportunities in the wage/salary sector outweigh the negative effects of limited demand and access to capital” (p. 25). However, these reports only measured the business creation on a static perspective. As start-up firms face the grueling challenges of an economic downturn, these firms faced lower consumer spending and therefore, lower potentials for financial returns. Finally, using Drucker’s theories, specifically, “Drucker’s perspective that firms seeking to survive in turbulent times should (a) focus upon adopting entrepreneurial innovative solutions to sustain business performance and (b) recognise the importance of strategic flexibility” (Chaston, n.d., p. 2), new startup ventures during economic downturn provide new entrepreneurs with greater challenges that require application of an intuitive style, generally manifested by senior managers of large organizations. As emphasized by Chaston (n.d.), “in the face of uncertainty or limited information, senior managers have a tendency to rely on intuition. Ritchie et al. (2007) found a positive relationship between executive intuition and achieved financial performance. Krueger (2000) has suggested that entrepreneurial individuals may be biased towards utilising an intuitive cognitive style” (p. 27). Entrepreneurs, on the other hand, were noted to apply a rational and effectual reasoning (Sarasvathy, 2005), in contrast to intuitive style. Thus, the length of experience and intuitive style applied by senior managers which were deemed to be effective in turbulent times and not appropriately applied by budding entrepreneurs could have contributed to business closures and bankruptcies that were highly evident in the recession. Conclusion A. Summary of Main Points of Arguments The current research essentially proffered pertinent issues relative to the impact of the 2008 financial crisis on entrepreneurial activities, particularly as it affected the rate new businesses were established or current businesses closed or even to the extent of declaring bankruptcy. From various studies and research publications, one eventually determined that the economic downturn created a net decline in the amount of new businesses opened and a relatively high number of bankruptcies reported during the period under review. B. Answers to the Research Questions The answers to the defined research questions, therefore, are as follows: • In the recent economic crisis, how many new businesses in the United States were recorded? From the information gathered and published by the SBA, a total number of 626,400 were opened in 2008 and 552,600 in 2009; reflecting an 11.78% decline. How many existing businesses were closed or filed bankruptcy? The total number of existing businesses that closed were 663,900 in 2008 and 660,900 in 2009; again reflecting a 0.45% decline. However, there was significantly large number of businesses that declared bankruptcies totaling 43,546 in 2008 to 60,837 in 2009; or a staggering 40% increase from the two-year period since the financial crisis was reported. • Aside from economic factors, were there other contributory factors that led to opening new businesses or closing existing ones? From the review of related literature, it was evident that the opening of new businesses was initially spurred from the number of people who lost their jobs and were apparently unemployed. According to the study of Fairlie (2010/2011), these people opted to open new businesses, manifesting a surging of ‘necessity’ entrepreneurship during the period. However, as statistics would reveal, this occurrence was a temporary lift and eventually, a net decline in entrepreneurial activity. On the contrary, business closures and bankruptcies increased due to strict credit, the reluctance of the bank to provide loans to start-up businesses, the high costs of federal regulations especially in small firms, and the unemployment rates that made consumers cut their spending. • What entrepreneurial theories were eminently applied during economic crisis to ensure survival? Using Drucker’s theories of adopting innovative solutions to business challenges during turbulent times, in conjunction with applying flexibility in strategies, most small business ventures that opened during the economic crisis left entrepreneurs with challenges beyond their access to internal and external resources. Further, the most effective strategies that senior managers of large organizations implemented during the period relied on the leaders’ intuitive cognitive abilities and length of experience in the business. To ensure survival, entrepreneurs must learn to be flexible in using intuitive style versus their effectual and rational reasoning and increase applying their creative and innovative approaches to problem-solving and decision-making in turbulent environments. It still boils down to the innate talents, skills and knowledge of entrepreneurs as assuming proactive stances in capturing opportunities in the external environment, their ability to bear the risks of uncertainty, and their role as arbitrageurs. C. Outstanding Issues for Further Research The current research used a very limited time frame, due to the availability of information on the subject. If extended time and resources would permit, the research on the effects of the 2008 economic crisis to entrepreneurial activity could be extended in time frame to another two to three more years (from 2008 up to 2012) to generate a more comprehensive and conclusive pattern. Further, the number of business establishments opened and closed, and filed for bankruptcies were restricted to the United States. Future research could focus on determining the effect of the economic crisis, likewise reverberating globally, on business establishments in other developing countries worldwide. By doing so, a more conclusive result could be generated to validate the consistency of the findings. The link between entrepreneurship and economic growth has been touched and supported in various studies. The current research found that there is a decline in entrepreneurial activity during the economic downturn. However, there have been some large corporations that have been established during a recessionary period and have proven to succeed. These instances could likewise be delved into as some organizations could have survived and surpassed the economic crisis with flying colors. Reference List Dej00: , (Dejardin 2000), Dav08: , (Davis 2008), Sha11: , (Shane, The Great Recession’s Effect on Entrepreneurship 2011), Sha11: , (Shane, The Great Recession’s Effect on Entrepreneurship 2011), Read More