Some observers argue that self-employment is counter-cyclical. Focusing on people’s decisions to go into business for themselves, these researchers argue that some of the people who lose their jobs when the economy contracts enter into self-employment, rather than becoming unemployed or exiting the labor force. Government data analyzed by Robert Fairlie at the University of California at Santa Cruz on behalf of the Kauffman Foundation supports this argument, showing that the rate at which people transitioned into self-employment rose during the Great Recession.

However, as I have mentioned here before, the focus of researchers on entry into self-employment in economic downturns is misleading. The number of self-employed people is the product of both entry into and exit from self-employment. If the rate of exit from self-employment exceeds the rate of entry, then the number of self-employed people will decline.

During economic downturns, those in business for themselves have a harder time accessing capital and face reduced demand for their products and services. As a result, when the economy contracts, the rate at which the self-employed close up shop rises. Whether the number of self-employed people goes up or down during a recession depends on whether the recession has a bigger effect on self-employment entry or exit.

To see if the number of self-employed tends to increase or decrease during recessions, I looked at data from the Current Population Survey, which tracks the number of non-agricultural self-employed people monthly since 1948. Using the start and end dates of the 11 recessions that the National Bureau of Economic Research says occurred in the United States between January 1948 and May 2014, I compared the number of non-agricultural unincorporated self-employed in the month before the recessions began with the number in the final month of the recessions.

The numbers are surprising. In six of the recessions, the number of self-employed declined, while in five of them, the number increased. Moreover, in three of the contractions in which self-employment increased, the number of people in private sector wage employment also rose (1960-1961, 1969-1970, and 1980 recessions), suggesting that the downturns had mild effects on the labor market overall. Because the positive effect of economic downturns is predicated on the idea that people enter into self-employment because they lose their jobs, it is difficult to interpret what happened in those recessions in which private sector wage employment increased.

In three of the recessions in which private sector wage employment declined (1948-1949, 1973-1975, and 1981-1982 recessions), the number of self-employed rose. In five recessions in which private sector wage employment declined (1953-1954, 1957-1958, 1990-1991, 2001, and 2007-2009 recessions), the number of self-employed declined.

The recessions in which self-employment fell were not more severe than the recessions in which self-employment rose. The median recession of the 11 I looked at was the 1980 recession, in which the decline in gross domestic product (GDP) was 2.0 percent from peak to trough. In three of the recessions in which the decline in GDP was greater than the median, self-employment fell, but in two of them self-employment rose. In two of the recessions in which the decline in GDP was less than the median, self-employment declined, and in three of them self-employment rose.

It’s interesting to note that declining self-employment is a hallmark of more recent recessions. In the last three economic downturns (1990-1991, 2000, and 2007-2009 recessions), the number of unincorporated self-employed people has fallen. In recent times, at least, the number of self-employed does not go up when the economy contracts.

Courtesy: Small Biz Trends