Young firms (less than five years old), more so than small businesses, are important drivers of economic growth, particularly with respect to employing young people. Since many new businesses are, in part, financed by entrepreneurs’ personal wealth, there is a positive correlation between home prices and young-firm creation.
A new paper from the National Bureau of Economic Research confirms the above:
The Great Recession and its aftermath saw the worst relative performance of young firms in at least 35 years. More broadly, as we show, young-firm activity shares move strongly with local economic conditions and local house price growth. In this light, we assess the effects of housing prices and credit supply on young-firm activity. Our panel IV estimation on MSA-level data yields large effects of local house price changes on local young-firm employment growth and employment shares and a separate, smaller role for locally exogenous shifts in bank lending supply. A novel test shows that house price effects work through wealth, liquidity and collateral effects on the propensity to start new firms and expand young ones. Aggregating local effects to the national level, housing market ups and downs play a major role – as transmission channel and driving force – in medium-run fluctuations in young-firm employment shares in recent decades. The great housing bust after 2006 largely drove the cyclical collapse of young-firm activity during the Great Recession, reinforced by a contraction in bank loan supply. As we also show, when the young-firm activity share falls (rises), local employment shifts strongly away from (towards) younger and less-educated workers.
The abstract omits one important question: should we embrace the boom and bust cycle or prefer slower, more stable growth to encourage more young firm creation?
The authors find that while booms lead to an expansion of young firms, the subsequent busts wipe out positive gains and then some, with negative effects on economic recovery more broadly:
[H]ousing busts and credit crunches hurt younger and less-educated workers through their particular effects on the fortunes of younger firms in addition to their broader effects on local economies. [Previous research] show[s] how firm entry and exit behavior amplifies the effects of common shocks and propagates their effects forward in time. Seen in this light, our results suggest that the housing market bust and the credit supply contraction during the 2007-2010 period slowed the recovery from the recession through their negative effects on business formation and young firms.