Group status and entrepreneurship

Do unfettered markets produce too many or too few entrepreneurs? Two seminal papers [Stiglitz and Weiss (1981) and de Meza and Webb (1987)] obtained ambiguous answers based on di¤erent assumptions about the character of information asymmetries in credit markets. The present paper approaches the same question but using a labour market model in which individuals derive utility from income and occupational group status. Income is determined by ability, while occupational group status for entrepreneurs depends on the average entrepreneurial income (due to ex post screening by banks), whereas status for wage employees depends on their own ability (due to ex ante screening by employers). Thus, individuals create externalities through their occupational choice. It is shown that there can be too many or too few entrepreneurs in equilibrium depending on the marginal returns to ability in entrepreneurship relative to paid-employment; this enables the researcher to use independent evidence about marginal returns to ability to identify the relevant equilibrium that will be likely to arise in practice, together with the likely appropriate policy responses. Based on this approach, we suggest that there may be too many (low ability) entrepreneurs in the USA.