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Wealth, Human Capital and the Transition to Self-Employment

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Abstract

Although the debate about the effect of wealth on entrepreneurship or self-employment is now almost two decades old, there is little consensus among researchers about the significance of wealth as a determinant for self-employment. In this paper, we shift the focus from whether potential entrepreneurs, as a group, are credit constrained, to whom among potential entrepreneurs is credit constrained. We consider the impact of education and experience on the probability of choosing self-employment, in an environment where individuals may be credit constrained. We find that for individuals with low human capital, wealth and entrepreneurial entry are negatively related, while wealth has no statistically significant effect on entry for individuals with medium to high human capital. This result is puzzlingly at odds with the classic Evans-Jovanovic model for entrepreneurial entry. We discuss one possibility for reconciling the two.

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Notes

  1. Early research on this topic has consistently suggested that individuals face binding liquidity constraints in entrepreneurial choice decisions [Evans and Jovanovic, 1989; Holtz-Eakin et al. 1994; Blanchflower and Oswald 1998; Quadrini 1999]. This view has recently been challenged by Hurst and Lusardi [2004] who argued that liquidity constraints are not binding for aspiring entrepreneurs over a majority of the wealth distribution. Their evidence has generated renewed interest in the question of liquidity constraints and entrepreneurship, and it has been countered by empirical [Fairlie and Krashinsky 2006] and theoretical work [Cagetti and De Nardi 2006].

  2. Some of the prominent papers in this line of research are listed in Footnote 1.

  3. We expect the transition to self-employment to be distinct for unemployed individuals, in terms of the factors and motivations affecting their labor market decisions.

  4. Net worth will be used interchangeably with wealth in our discussion below.

  5. Individuals at or below the 50th percentile have less than 6 months of work experience.

  6. The partial F-statistic (like partial R2) provides us with a test of the relevance of our instruments. We find a partial F-statistic of 12.17 when we regress net worth on our instrument, as well as all the exogenous variables in our sample and test the null of whether the coefficient on our instrument is zero. According to the cutoff of 10 provided in Staiger and Stock [1997], housing price residuals satisfy the relevance requirement for the full sample.

  7. We do not have complete information on the market value of each individual's house for two different years over which to calculate the change in home value, so the number of observations in our IV regressions is significantly lower than for our regular probit regressions.

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Acknowledgements

We are grateful to Christopher Carroll, Thomas Lubik, Bart Moore, and seminar participants at the Eastern Economic Association Meetings for helpful comments. Berna Demiralp acknowledges the financial support of the Office of Research, Old Dominion University, through its Summer Research Fellowship Program.

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  1. Optimal Solutions Group, College Park, 20740, MD, USA

    Berna Demiralp

  2. Department of Economics, Fordham University, Bronx, 10458, NY, USA

    Johanna L Francis

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  1. Berna Demiralp
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Demiralp, B., Francis, J. Wealth, Human Capital and the Transition to Self-Employment. Eastern Econ J 39, 72–92 (2013). https://doi.org/10.1057/eej.2012.5

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