Tuesday, February 5, 2013

Is there a link between housing and startups?

In a previous post I described the puzzling collapse of startup activity prior to the Great Recession. This has been well documented by these authors and others. I mentioned that one possible explanation is the one offered by Moscarini and Posten-Vinay (based on the stylized fact that startups tend to be small). But there may be other things going on as well.

What's interesting about this decline in startup activity is that not only did it precede the broader recession, but it also coincided with the housing collapse. Consider Figure 1 (click for larger image), which uses annual data:

Figure 1

Figure 1 plots startup activity in terms of the number of startup firms and the number of jobs created by startups, against the left axis, and the Case Shiller house price index and home equity against the right axis. Everything is normalized by year 2000 levels. The timing is interesting, particularly if we think Case Shiller reports reality with a lag.

This pattern holds when considering shares instead of quantities; consider Figure 2 (click for larger image), which also uses annual data:

Figure 2

This figure is similar, with startup activity on the left axis and housing stuff on the right axis, but this time I've used job creation from startups as a component of the economywide job creation rate, and startups as a percent of all firms.* Again, it appears that housing wealth and startup activity are moving together.

It turns out that some more formal analysis confirms the result that there exists a relationship between house prices and startup activity, see here.

And just to remind readers that the recession started after the decline in startup activity, consider Figure 3 (click for larger image), which uses quarterly data:

Figure 3

Observe that residential investment dives about a year prior to other investment series. So there seems to be a puzzle here--why did startup activity begin declining before the broader economy slowed down, and does the answer have anything to do with housing? We don't know. It is likely that housing plays an important collateral role for many entrepreneurs, so a collapse in housing values could tighten credit conditions for young firms. This is one of the topics of my current PhD research.

By the way, here are some other posts in which I use the incomparable Business Dynamics Statistics:

*Ignore FHFA as one of the data sources listed for Figures 1 and 2; that series looks similar, but I took it out of the plots for congestion reasons, and I'm too lazy to fix it now.