João Ricardo Faria, Ph.D., IPED, University College, University of Texas El Paso, 500 West University Avenue, El Paso, Texas 79968-0703, El Paso, TX 79968-0703, Juan C. Cuestas, Ph.D., Economics, Nottingham Trent University, Burton Street, Nottingham, NG1 4BU, United Kingdom, and Estefanía Mourelle, Ph.D, Economía Aplicada II, Universidade da Coruña (Spain), Campus de Elviña s/n, A Coruña, 15071, Spain.
Entrepreneurship is one of the main engines of growth in modern economies [e.g., Thurik, 2008], so its role in impacting unemployment is of utmost importance. During most part of the twentieth century, large firms occupied the main role in the economy; however, empirical studies have shown that small businesses have become more important in the 1970’s and 1980’s due, among other factors, to economic instability, technological innovations and globalization.
As economic growth is linked to changes in unemployment, through the growth rate form of the Okun’s law [e.g. Prachowny, 1993], one can safely assume that there is a relation between entrepreneurship and unemployment. However, what type of relationship is this? It is important to stress that the economic growth channel is just one of the possible ways to link entrepreneurship with unemployment but there are other alternatives.
It is well known that the link between unemployment and entrepreneurship is a relevant empirical relationship that, so far, is characterized by ambiguity. Some studies have found that entrepreneurship and unemployment are inversely related, but others have come to the opposite conclusion, finding that unemployment is associated with greater entrepreneurial activities. This ambiguity has led researchers to postulate that the relation between entrepreneurship and unemployment is dynamic, as in Audretsch et al. (2001). It also may be the case that the dynamic relation is nonlinear, possibly cyclical, as found by Faria et al. (2008). It is important to emphasize that the dynamic and nonlinear nature of the relationship does not necessarily contrast with the views exposed above; it may push the proponents of the above cited literature to consider the feedback mechanisms derived from their views on the relationship between entrepreneurship and unemployment.
This paper contributes to this line of research by assessing the Granger-causality between entrepreneurship (measured by business ownership per labor force) and unemployment for nine OECD countries. It also studies whether or not there is some nonlinear causality between them, based on a smooth transition autoregression with exogenous transition (STAR-EXT) estimation. The results reveal a bidirectional and nonlinear relation between business creation and changes in unemployment.