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What does firm creation tell us about Europe's recovery from crisis?

Leora Klapper's picture

A financial crisis is a difficult time to start a business. Credit is tight, demand is low, and the future is uncertain. Even in recovery periods, entrepreneurs may be skittish about making the enormous sacrifices necessary to launch a new enterprise and lenders may be unwilling to lend to new borrowers. New data from the Entrepreneurship Database – a collaborative effort between the Bank's Development Economics Group (DEC) and Doing Business - provide an interesting look at the relationship between new firm creation and the recent financial crisis and ongoing recovery. The main indicator is new firm entry density, defined as the ratio of new registrations of limited liability companies to the working age population. The data show that new firm entry density (“entry density”, for short) dropped sharply in response to the 2008-09 financial crisis but by 2011 had recovered to pre-crisis levels in many economies.

New firm entry density over time: Percent change in entry density as compared to 2004 levels (Source: Entrepreneurship Database, 2012)

In the pre-crisis period from 2004 to 2007, entry density increased at an average rate of 11 percent per year among a sample of 15 high-income European countries. New firm registrations dropped sharply in most of these countries beginning in 2008 and continued to fall in 2009. These declines were often dramatic: Spain experienced 25-30% annual drops in entry density in both 2008 and 2009. By 2010, new firm registrations showed clear signs of recovery in the majority of economies and by 2011 entry densities had recovered to slightly below than the 2007 peak, on average.

But aggregate trends mask considerable variation in entry density patterns. Indeed, the recovery trend is weak or non-existent in many economies. In Ireland and Spain, new firm registrations bottomed out in 2009 but growth since then has been anemic, and 2011 levels remain far below those of 2004. In Italy and Greece, entry density did not fall as far below 2004 levels but the values in both countries continue to slide.

What explains this heterogeneity?  Our research shows that in a sample of 92 countries, those with more developed financial systems experienced sharper declines in new firm registrations. One possible explanation is that new firms in countries with more developed financial systems are more dependent on external financing and so the absence of credit has a particularly damaging effect on entrepreneurship in these economies. We also find a strong correlation between measures of crisis intensity and drops in entry density. This is certainly borne out by the examples of Greece, Ireland, Italy, and Spain.

With future rounds of data we hope to provide a more rigorous investigation of the patterns of crisis and recovery as they relate to new firm creation.
 

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Submitted by SANAT KUMAR GOSWAMI on
NICELY PRESENTED. IF IT ACTUALLY HAPPENS, WE THE PEOPLE OF DEVELOPING COUNTRIES LIKE INDIA, WILL BE DELIGHTED. BECAUSE, AFTER LIBERALISATION, HAS BECOME VIRTUALLY A FREE TRADE COUNTRY LIKE OTHER COUNTRIES. NATURALLY, ECONOMIC HEALTH OF INDIA DEPENDS MAINLY ON THE HEALTH OF OTHER COUNTRIES. BUT, WHAT WE HAVE REALISED IS THAT THE CONCEPT OF MARKET ECONOMY HAS NOT YET PROVED A BETTER OPTION FOR OUR COUNTRY. PERHAPS WE WERE BETTER IN PRE-LIBERALISATION ERA. SANAT KUMAR GOSWAMI. CALCUTTA, WEST BENGAL.

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