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Subsistence Entrepreneurs and Misallocation

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  • Kevin Donovan

    (University of Notre Dame)

Abstract

Empirical evidence suggests that many individuals in developing countries operate businesses not due to some superior skill or idea, but because they lack the opportunity to become salaried employees. In a model with incomplete markets, occupational choice, and frictional job search, I argue that this is due to the interaction of low unemployment benefits and financial market underdevelopment. The resulting misallocation along the extensive margin between salaried positions and business ownership generates a larger left tail of firm size and a significantly smaller quantitative impact of targeted lending to poor entrepreneurs. Model predictions are then tested with individual-level surveys of both Chilean and Mexican microenterprise owners. Evidence shows that misallocated owners have lower profit conditional on observable inputs and are more likely to have left their last salaried position involuntarily. Both are consistent with the model.

Suggested Citation

  • Kevin Donovan, 2014. "Subsistence Entrepreneurs and Misallocation," 2014 Meeting Papers 771, Society for Economic Dynamics.
  • Handle: RePEc:red:sed014:771
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    References listed on IDEAS

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    8. Gollin, Douglas, 2008. "Nobody's business but my own: Self-employment and small enterprise in economic development," Journal of Monetary Economics, Elsevier, vol. 55(2), pages 219-233, March.
    9. Marco Cagetti & Mariacristina De Nardi, 2006. "Entrepreneurship, Frictions, and Wealth," Journal of Political Economy, University of Chicago Press, vol. 114(5), pages 835-870, October.
    10. Benjamin Moll, 2014. "Productivity Losses from Financial Frictions: Can Self-Financing Undo Capital Misallocation?," American Economic Review, American Economic Association, vol. 104(10), pages 3186-3221, October.
    11. Pedro S. Amaral & Erwan Quintin, 2010. "Limited Enforcement, Financial Intermediation, And Economic Development: A Quantitative Assessment," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 51(3), pages 785-811, August.
    12. García-Santana, Manuel & Pijoan-Mas, Josep, 2014. "The reservation laws in India and the misallocation of production factors," Journal of Monetary Economics, Elsevier, vol. 66(C), pages 193-209.
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