Student loans and small businesses don’t mix.
The higher the student-loan debt in an area, the lower the net creation of very small businesses, says a report from the Federal Reserve Bank of Philadelphia, using data culled from the Census Bureau and Equifax consumer-credit statistics.
In the study, published last year, researchers looked at student debt across the U.S. by ZIP Code and compared it with small-business formation in those areas. Between 2000 and 2010, a one-standard-deviation increase in student debt in a ZIP Code led to an average 25% reduction in the number of very small businesses, those with one to five employees.
The conclusion, the researchers believe, is that prospective entrepreneurs are so burdened with student debt that they simply can’t take on any more debt to start a business.
“It reinforces the notion that one has to take personal responsibility for making good and wise choices,” says co-writer Brent Ambrose, who is director of the Institute for Real Estate Studies at Pennsylvania State University’s Smeal College of Business.
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The report, co-written by Larry Cordell, a vice president at the Philadelphia Fed and Shuwei Ma, a senior specialist at the bank, found these effects only for the smallest businesses, which are more likely to take on debt that’s secured by the founder’s own personal credit.
The formation of larger firms wasn’t affected, which “we interpret to mean that these firms have greater access to outside capital,” the researchers wrote.
They found the most student debt in the Midwest’s Rust Belt, which was far from the places where the most new businesses were formed: the East and West Coasts.
Stalling small-business formation may have broad consequences for the economy. Ninety-nine percent of all American companies are small businesses, which create 60% of all new jobs, according to Small Business Administration data the authors cite.
If student-debt burdens are cramping graduates’ ability to start companies because they can’t borrow more money while their school loans are outstanding, that could have negative consequences for the economy as a whole.
The risk of problems increases as the amount of student debt balloons. The total has now reached $1 trillion, after tripling between 2004 and 2012, according to the paper. During the financial crisis and subsequent recession, Americans pared their debt—except for student loans, which grew to 10% of all consumer debt in 2012, up from 2.9% in 2004.
“We need to be concerned about the long-run economic effects of greater student debt,” Mr. Ambrose says.
That said, the report comes with a caveat: While the paper does identify a correlation between higher student debt and lower small-business formation, the authors can’t prove their theory that heavy debt burdens can keep people from pursuing entrepreneurship.
The data could be interpreted a different way, Mr. Ambrose notes: that graduates with high debt prefer to move to areas with large employers that offer the potential for stable employment, which would make those areas look more debt-burdened and less successful at creating business.
“We are working on trying to find a way to get identification to prove the causal link, but haven’t found it yet,” he says.
Ms. Schoenberger is a writer in New York. She can be reached at email@example.com.