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Liquidity Constraints, Household Wealth, and Entrepreneurship Revisited

  • Fairlie, Robert W.
  • Krashinsky, Harry A.

A large body research shows a positive relationship between wealth andentrepreneurship and interprets the relationship as providing evidence of liquidity constraints.Recently, however, the liquidity constraint interpretation has been challenged because of thefinding that the relationship between business entry rates and assets is flat throughout most of theasset distribution and only rises dramatically after this point (Hurst and Lusardi 2004). Wereexamine the liquidity constraint hypothesis in three ways. First, we demonstrate that examiningthe relationship separately for those who experience a job loss and those who do notreveals generally increasing entry rates through the wealth distribution for both groups. Basedon the entrepreneurial choice model of Evans and Jovanovic (1989), these two groups facedifferent incentives, and thus have different solutions to the entrepreneurial decision. We alsofind evidence of a stronger relationship between entrepreneurship and a different measure ofwealth – net housing equity – for the two groups. Second, we examine the liquidity constrainthypothesis using a two-period simulation model that extends the Evans and Jovanovic (1989)model. The model shows how exogenous wealth shocks can be used to accurately identify thepresence of liquidity constraints even allowing for endogenous saving and correlated abilities.Third, we provide new evidence from matched Current Population Survey (1993-2004) data tostudy whether changes in housing prices affect self-employment entry. We find thathousing appreciation measured at the MSA-level is a significantly positive determinant of entryinto self-employment after controlling for changes in local economic conditions and otherfactors. Our estimates indicate that a 10 percent annual increase in housing equity increases themean probability of entrepreneurship by 17 percent and that the effect is not concentrated at theupper tail of the distribution. These estimates are not sensitive to controlling for pre-existingtrends in housing prices suggesting that the results are not being driven by expected localeconomic growth.

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Paper provided by Department of Economics, UC Santa Cruz in its series Santa Cruz Department of Economics, Working Paper Series with number qt6hv0m2q6.

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Date of creation: 07 Aug 2011
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Handle: RePEc:cdl:ucscec:qt6hv0m2q6
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