Skill bias, financial frictions, and selection into entrepreneurship

Financial frictions adversely affect productivity by discouraging entrepreneurship, which is often measured by the self-employed. This paper distinguishes different types of self-employment when studying this question. Using micro data for 77 countries from all income levels, we show that employers’ labor shares are increasing with GDP per capita, whereas own-account employment (self-employed without employees) is decreasing. We also find almost universally negative selection on education into own-account status relative to wage workers and positive selection into employers. To quantitatively match these facts, we introduce skill-biased technological change across countries in an occupational choice model with financial frictions. Our model predicts an average of 19% output gains in low-income countries from removing financial frictions. In contrast, an alternative model with skill-neutral technological change cannot match the high own-account employment share in low-income countries, thus overestimating the output gains by 13 percentage points.