Occupational Choice and the Quality of Entrepreneurs

Abstract:     
This paper focuses on the quality of entrepreneurs when individuals, who differ in terms of entrepreneurial ability and wealth, choose between entrepreneurship and wage-earning. The model extends the contracts to a general equilibrium in which both the risk-free interest rate (i.e., cost of loanable funds) and the wage rate are endogenous. The poor, the lower-middle, the upper-middle, and the rich wealth classes form endogenously. In some economies -- but not in all -- a small tax on entrepreneurs used to subsidize workers can increase the average quality of entrepreneurs and welfare. Unlike the previous literature, the reason for this policy is not overinvestment by entrepreneurs as the aggregate level of investment is fixed in the model. The policy rather works by swapping some low-ability upper-middle class entrepreneurs with an equal number of high- and low-ability poor-class workers and thus by affecting the loan supply to the banks. Therefore, that the interest rate is endogenous is crucial in getting this result.

Keywords: entrepreneurship, general equilibrium contract theory, occupational choice, success tax, wage subsidy

JEL Classifications: D43, D82, H25, L26

Working Paper Series