Too much of a good thing? The macro implications of massive firm entry

Policies supporting small businesses are popular among policymakers but often criticised by economists for their potential to distort the economy. This paper provides a comprehensive evaluation of a unique policy that subsidises the first employee. Empirically, we find that the policy led to a surge in the number of firms employing exactly one employee, without a noticeable effect on the number of firms with two or more employees. A simple frictionless general equilibrium model of occupational choices predicts the empirical facts remarkably well. Leveraging our model, we show that the general equilibrium effects on wages and aggregate output are likely to be small. However, the policy is expensive. Our findings support the traditional view that size-dependent subsidies distort the optimal allocation of resources.