Risky Business: How Job Insecurity Pushes Employees Towards Entrepreneurship

Dec. 02, 2024

Sweden, a country renowned for its robust labor protections, unexpectedly became the stage for a natural experiment revealing how unemployment risk can drive entrepreneurship. A recent study examines how changes to Sweden’s strict "last-in-first-out" (LIFO) dismissal rules reshaped the labor market, nudging employees to start their own businesses without compromising the quality of their ventures.

Stockholm University’s Ai Jun Hou, Sara Jonsson, Qinglin Ouyang, and Deakin University’s Xiaoyang Li examined the effects of a 2001 reform to Sweden’s LIFO rule, which governs how firms prioritize layoffs. The change allowed small firms to exempt two employees from the strict seniority-based system, exposing many workers to higher unemployment risk. Researchers found that the policy led to a significant uptick in entrepreneurship.

A Nudge Toward Independence

The authors used Swedish administrative data to track the transitions of salaried employees into business ownership. They found that the reform increased entrepreneurship by 2.25 percentage points in affected groups over five years, representing a 33% rise compared to employees whose job security was unchanged.

“Greater unemployment risk leads to an increased tendency for employees to become entrepreneurs, and this effect is more pronounced for employees with longer tenures,” the authors say.

No "Forced Entrepreneurs"

The study challenges the assumption that employees turned entrepreneurs by necessity would underperform, as the shift reflects desperation rather than opportunity, and offers a more nuanced picture.

The study assessed business outcomes using metrics such as survival rates, value added, and income growth. The findings revealed no evidence that these "risk-pushed" entrepreneurs were rushing into poorly planned ventures. On the contrary, their businesses exhibited similar or even slightly better performance metrics compared to others.

“Entrepreneurs exposed to greater unemployment risk did not underperform relative to otherwise similar entrepreneurs,” the authors say.

Broader Implications for Policymakers

For a country like Sweden, which ranks in the bottom half among OECD countries for entrepreneurial activity, the results are significant.
“Our study reveals that a rigid employment protection policy is an impediment to entrepreneurship,” the authors say, adding that even small reductions in job security can spur productive entrepreneurial activity.

The findings may resonate beyond Sweden, where over 80 countries worldwide have similar seniority-based employment protections, the authors note.

“According to the World Bank in 2015, over 80 other countries had priority rules in case of redundancy similar to Sweden’s. Our findings have important implications for designing policies to spur entrepreneurship,” they say.

The Entrepreneurship Puzzle

The study contributes to a broader discussion about why entrepreneurship remains relatively rare, even in developed economies. Traditional barriers like access to capital and market regulations have long been considered the primary culprits. However, the Swedish case underscores the importance of labor market dynamics, the authors say.

"Our findings indicate that even a slight drop in job security can spur significant and productive entry into entrepreneurship," they add.