The effect of the Great Recession on the employment growth of young vs. small firms in the Eurozone

Highlights

• Which firms were most affected by the Great Recession?

• We study firm-level employment growth in ten Eurozone economies

• During the crisis young firms remained the main contributors to net job creation

• However, contrary to small firms, they experienced a sharper drop in growth rates

• The effect is not related to firm productivity, but to dependence from external finance

• Heterogeneous effects are found by sector and core-periphery macroeconomic status

Abstract

This paper examines the uneven impact of the Great Recession on firm-level employment growth across firm size and age classes. Based on firm-level data from ten Eurozone countries, we show that, notwithstanding the negative impact of the crisis, young firms were the most dynamic group of firms and prime contributors to net job creation even during the recession. However, conditional on survival, young firms experienced a sharp drop in their employment growth rates, whereas small firms were mostly unaffected. By using industry-level measures of external financial dependence, we then show how financial frictions were a driver of the growth rates slowdown of young firms.

Introduction

Understanding the role played by small and young businesses in the process of economic growth has long attracted the interest of both scholars and policy makers (Acs, Audretsch, Strom, 2009, Audretsch, 2002). In recent years, new evidence has emerged on the substantial contribution of young firms to aggregate net job creation (Haltiwanger et al., 2013), which has led to a reassessment of previous studies that had stressed the importance of small firms (Birch, 1981, Neumark, Wall, Zhang, 2011). However, the prominent role of young firms might not necessarily hold in times of economic distress. The available empirical evidence on how firms respond to recessions has yielded mixed results: some authors argue that downturns hurt large firms the most (Moscarini, Postel-Vinay, 2012, Varum, Rocha, 2013) while others argue that they are especially harmful to small (Gertler and Gilchrist, 1994) or young firms (Bartz, Winkler, 2016, Fort, Haltiwanger, Jarmin, Miranda, 2013, Huber, Oberhofer, Pfaffermayr, 2017). The different results imply considerable disagreement over the mechanisms through which recessionary shocks propagate in the economy, including the role played by financial frictions.

Given the conflicting results found in the literature, in this paper we provide new and original evidence on the impact of the economic downturns on employment growth across firm size and age by exploiting the double-dip recession experienced by Eurozone countries from 2008. The crisis had a very uneven effect on European economies and it is essential to understand what types of firms were especially affected by the downturn across countries. This is even more important at the time of writing, when the COVID-19 pandemic is causing a new downturn that will require appropriate policy responses. Our study aims to identify whether small or young firms were most vulnerable to the crisis, and to what extent credit market frictions were behind different growth performances. Drawing on the econometric approach developed by Haltiwanger et al. (2013), we find that, conditional on survival, young firms were the most dynamic businesses in terms of net job creation, but suffered relatively more than small firms during the double-dip recession. Conversely, small firms were mostly unaffected by the recession and, if anything, performed better compared with the pre-2008 period. We show that these results are robust to the inclusion of labour productivity, thus indicating that the decline in the growth rates of young firms is not driven by lower efficiency.

Furthermore, we explore whether financial frictions can explain the drop in employment growth rates of young firms by using industry-level measures of external financial dependence as in Rajan and Zingales (1998). Results indicate that financial frictions play a significant role since the relative decline of employment growth is more pronounced for young firms operating in sectors with higher external financial dependence. We then extend the analysis to consider the heterogeneous impact of the recession on sectors and countries. We find that the vulnerability of young firms to this double-dip recession is particularly high within manufacturing and high-tech sectors, and higher for peripheral than for core Eurozone economies.

The paper is structured as follows. Section 2 reviews the relevant literature. In section 3 we describe the data along with the econometric approach. Section 4 presents the results, section 5 provides a series of robustness checks and section 6 concludes with a reflection on the key results of the paper and their implications.