Misallocation of capital in a model of endogenous financial intermediation and insurance

Misalloca ion o Capi al in a Model o Endogenous Financial In e media ion and Insu ance∗ Radim Boh´aˇcek† CERGE-EI Hugo Rod ´ıguez Mendiz´abal‡ Ins i u e o Economic Analysis (CSIC) and BGSE Feb ua y 15, 2011 Abs ac In his pape we analyze p oduc i i y and wel a e losses om capi al misalloca ion in a gene al equilib ium model o occupa ional choice and endogenous financial in e media ion. We s udy he effec s o bo owing and lending, insu ance, and isk sha ing on he op imal alloca ion o esou ces. We find ha financial ma ke s oge he wi h gene al equilib ium effec s ha e la ge impac on en ep eneu s’ en y and fi m-size decisions. Efficiency gains a e inc easing in he quali y o financial ma ke s, pa icula ly in hei abili y o alle ia e a financing cons ain by p o iding insu ance agains idiosync a ic isk. Keywo ds: Financial ma ke s and he mac oeconomy; Occupa ional choice; Pe sonal income and weal h and hei dis ibu ions JEL classi ica ion: E44; J24; D31 ∗Financial suppo om he G an agency o he Czech Republic 402/09/1340 and he In- s i u e o Economic Analysis (CSIC) is g a e ully acknowledged. Rod ´ıguez Mendiz´abal hanks he suppo o he Ba celona GSE esea ch ne wo k and o he Gene ali a de Ca alunya as well as he financial suppo o he MICINN (ECO2009-07958). We a e g a e ul o Juan Ca - los Conesa, Nezih Gune and he semina pa icipan s Uni e si a Au onoma de Ba celona o help ul commen s and sugges ions. All emaining e o s a e ou own. †CERGE-EI, Cha les Uni e si y and he Academy o Sciences o he Czech Republic, Poli ickych eznu 7, 111 21 P ague 1, Czech Republic. Co esponding au ho . Email: adim.b[email p o ec ed]. Phone: (+420) 775 379 336.) ‡Ins i u e o Economic Analysis (CSIC), Uni e si a Au onoma de Ba celona, Bella e a 08193, Ba celona, Spain. E-mail: [email p o ec ed]. 1 1 In oduc ion This pape analyzes he ole o insu ance on he alloca ion o p oduc ion inpu s in an economy wi h financial ic ions. I is mo i a ed by he inc easing e idence ha esou ce misalloca ion ac oss indi idual p oduc ion uni s may accoun o a subs an ial sha e o he income diffe ences we obse e ac oss coun ies. Hsieh and Klenow (2009) use mic oda a on manu ac u ing es ablishmen s in China and India o show ha ealloca ing capi al and labo o equalize ma ginal p oduc s o he ex en obse ed in he Uni ed S a es could inc ease manu ac u ing TFP up o 50 pe cen in China and 60 pe cen in India. Bane jee e al. (2003), Bane jee and Munshi (2004), o Al a o e al. (2008), who s udy income diffe ences caused by he alloca ion o esou ces ac oss he e ogeneous fi ms using da a o 80 coun ies, p esen e idence ha financial ma ke impe ec ions and misalloca ion o esou ces can explain a la ge pa o he TFP diffe ences be ween ich and poo coun ies. These insigh s ha e led many esea che s o ask why capi al is no alloca ed efficien ly ac oss fi ms. Among possible candida es, ic ions in financial ma ke s appea as a na u al explana ion o esou ce misalloca ion.1Because o lack o en o cemen , commi men o in o ma ion, high p oduc i i y fi ms a e no able o bo ow he necessa y esou ces o un hei businesses a he op imal size while low p oduc i i y fi ms su i e and do no exi he ma ke . In he quan i a i e mac o models, esou ce ealloca ion de i ed om emo ing inefficiencies in c edi ma ke s has la ge effec s on ou pu and measu ed TFP (see, among o he s, Bue a e al. (2010), E osa and Hidalgo-Cab illana (2010), o Moll (2010)). Using he e idence on financial ic ions and en ep eneu ial ac i i y p esen ed in he nex Sec ion, we build a dynamic gene al equilib ium model wi h he e o- geneous agen s wi h occupa ional choice, financial cons ain s and endogenous financial and insu ance ma ke s. Each agen compa es he expec ed alue he o she would ob ain om being a wo ke o he expec ed alue o becoming an en- ep eneu . A wo ke ecei es a wage while an en ep eneu es ablishes a fi m wi h capi al in es men , employs o he agen s as wo ke s, and ealizes p ofi om a dec easing- e u ns- o-scale p oduc ion echnology. As en ep eneu s mus com- mi esou ces o hei isky business p ojec s, agen s wi h low asse s bu high skills migh be cons ained in hei en y o fi m-size decisions. The occupa ional he e ogenei y is impo an as wo ke s ( oge he wi h he less p oduc i e o uncons ained en ep eneu s) lend hei asse s o en ep eneu s who can use hem mo e p oduc i ely. Financial in e media ion ha alloca es esou ces o he mos p oduc i e use could educe hese financing cons ain s and inc ease efficiency. T ans e ing esou ces om one agen o ano he is cos ly as financial in e media ies need capi al and labo o pe o m hese asks. The e o e, he le el o economic ac i i y and he le el o financial in e media ion a e join ly de e mined. 1Fo o he explana ions o esou ce misalloca ion see he e e ences in Res uccia and Roge son (2008). 2 We calib a e he pa ame e s associa ed wi h financial in e media ion by ma ching he sha e o he financial sec o bo h in GDP and in inpu ma ke s obse ed in he da a. Finally, we include he possibili y ha financial in e media ies also p o ide insu ance in addi ion o channeling c edi . We a e in e es ed in analyzing fi s , he ex en o which indi idual agen s endogenously decide o educe he isk hey ace, and second, whe he and by how much he endogenous insu ance ma ke s alle ia e he financing cons ain and imp o e he efficien alloca ion o esou ces.2 We simula e ou economies ha diffe in he quali y o financial in e media ion: we compa e alloca ions and dis ibu ion o esou ces in an economy wi hou financial in e media ion o a benchma k economy wi h bo owing and lending as well as o wo insu ance economies (wi h ex-an e insu ance and ex-pos isk sha ing). Ou esul s p o ide some answe s o a ecen pape by Hu s and Lusa di (2004) who challenge he iew ha pe sonal weal h is a key ac o o he decision o become an en ep eneu . Looking a diffe en weal h g oups, hey es ima e ha pe sonal weal h is s a is ically impo an only o he iches households in he op quin ile o he dis ibu ion. Since hese households a e qui e weal hy, i is difficul o in e p e he impo ance o weal h o hese households as a sign o bo owing cons ain s. And as he ini ial capi al o many en an s is a he small, i migh seem ha weal h cons ain is no a majo de e en o en ep eneu ship. Howe e , Quad ini (2009) a gues ha financial cons ain s may no be a de- e en o becoming an en ep eneu bu may affec in impo an ways he ini ial ope a ion o a business and i s u u e. This is wha we show in ou dynamic model. Financial ma ke impe ec ions keep he ini ial scale o businesses a below he op imal size. In o he wo ds, wha plays a c ucial ole is he impac o finan- cial cons ain s on he beha io o he en ep eneu a e he o she has made he occupa ional choice. Second, we find ha financial ma ke s do also affec he en y/exi decisions by gene al equilib ium effec s. A well unc ioning financial in e media ion makes pe sonal weal h less ele an when alloca ing p oduc i e capi al o manage ial skills: he mos alen ed en ep eneu s can en e and ope a e fi ms close o he op imal size. This in u n inc eases demand o labo and capi al. Highe equi- lib ium wages and in e es a es inc ease he oppo uni y cos o becoming an en ep eneu o he less alen ed agen s. This u he imp o es he skill composi- ion o en ep eneu s and inc eases he amoun o esou ces a ailable o he mos alen ed ones. We show in ou nume ical simula ions ha his gene al equilib ium mechanism inc ease he p oduc i i y h eshold o en an s: he e a e ewe bu mo e p oduc i e en ep eneu s and he median fi m size inc eases. Thi d, bo owing and lending by i sel may no be sufficien o he efficien 2Fo an exogenously imposed isk sha ing see Hea hco e e al. (2009). Ka ai ano e al. (2006) es ima e c edi ma ke impe ec ions due o limi ed liabili y and mo al haza d in Thailand. 3 alloca ion o capi al o en ep eneu ial skills. In ou model, en ep eneu s ace a financing cons ain as hey ha e o pay deb s and sala ies o wo ke s in each s a e o he wo ld, namely i he p ojec ails. Poo e en ep eneu s a e no willing o un fi ms close he op imal size i hey a e exposed o his la ge income isk. When financial ma ke s also insu e en ep eneu s agains hese po en ial losses, he alloca ion o esou ces becomes much mo e efficien . Rela i e o he economy wi hou financial ma ke s, ou benchma k economy wi h bo owing and lending inc eases he o al ac o p oduc i i y by 19.4% and wel a e by 17.5%. Bo h insu ance and isk sha ing inc ease efficiency by addi ional 7% and wel a e by 3%. Inc eased compe i ion among en ep eneu s educes hei p ofi s. All he wel a e gains apply o wo ke s who benefi om highe equilib ium wages and he possibili y o ecei e e u n on hei sa ings. O e all, we find ha highe quali y o financial ma ke s inc eases efficiency, imp o es a e age wel a e as well as educes inequali y. We show ha he efficiency gains ope a e h ough alle ia ed financing cons ain s. This is because, condi ional on a le el o weal h, high skill and high ma ginal p oduc i i y en ep eneu s can en e and/o expand hei fi ms, while gene al equilib ium effec s p o ide incen- i es o low skill en ep eneu s o educe hei fi ms o exi and become wo ke s. The pape is o ganized as ollows. Sec ion 2 summa izes he ela ionship be- ween financial in e media ion and en ep eneu ship in he Uni ed S a es. In he ollowing h ee sec ions we desc ibe ou economies ha diffe in he financial in- e media ion se ices hey p o ide. Fi s , we de elop he benchma k economy wi h bo owing and lending in e media ed by a compe i i e endogenous banking sec o . We hen add insu ance ma ke s ha offe ac ua ially ai isk sha ing and insu ance con ac s. Fou h, o efficiency compa isons we p esen an economy whe e he financial ma ke s a e missing. In Sec ion 6 we cha ac e ize he effec s o financial ma ke s on en ep eneu ial decisions. Resul s o nume ical simula ions a e p esen ed in Sec ion 7. Sec ion 8 concludes. 2 En ep eneu ial Ac i i y in he Uni ed S a es Fi s , we will b iefly desc ibe he ela ionship be ween financial in e media ion and en ep eneu ship in he Uni ed S a es. We ollow Gen y and Hubba d (2000) and define an en ep eneu as someone who combines up on business in es men wi h en ep eneu ial skill o ob ain he chance o ea ning economic p ofi s. Ac- co ding o he Su ey o Consume Finances (SCF 1989), 8.7% households epo ac i e business asse s g ea e han $5,000 (9.5% epo business asse s g ea e han $1,000). Simila ly, in he Panel S udy o Income Dynamics (PSID 1994), 10.4% o amilies own a business o ha e a financial in e es in some business en e p ise. The ollowing pa ag aphs ela e he weal h and income da a o occupa ional choice in he Uni ed S a es. 4 De Na di e al. (2007) documen ha U.S. en ep eneu s a e cha ac e ized by hei high p opensi y o accumula e capi al, isk aking, and commi ing skills and esou ces o hei businesses. The Gini coefficien o amily weal h is be ween 0.78 and 0.84, depending on he yea and su ey (PSID and SCF, espec i ely). The Gini coefficien o amily income is 0.45 in he PSID and 0.54 in he SCF. In he PSID, he op 1 pe cen o amilies owns a ound 29% o he o al household weal h and a ound 8% o he o al income. The op 5 pe cen owns al eady 50% o he weal h and ecei es 20% o he income. Finally, he op decile owns mo e han 60% o he weal h and ecei es mo e han 32% o he income. The pe cen age o business amilies inc eases in highe weal h classes: Quad ini (1999a) documen s ha abou hal o all amilies in he op 5% a e business amilies. A he same ime, he concen a ion o weal h among business amilies is no pu ely explained by he concen a ion o income. Quad ini (1999b) and Gen y and Hubba d (2000) epo ha en ep eneu s a e weal hy because hey no only ea n mo e income bu also sa e ela i ely mo e han wo ke s. En ep eneu s, being such a small ac ion o he popula ion, ecei e 22% o he o al income and own 40% o he o al weal h. The a io o weal h o income is abou wice as la ge o business amilies (6.77 e sus 2.94). En ep eneu ial po olios a e e y undi e sified. Gen y and Hubba d (2000) find ha ac i e businesses accoun o 42% o en ep eneu s’ asse s (e en in he op weal h classes). Also, en ep eneu s hold ela i ely less o hei weal h in liquid asse s. In he su ey o Cha ac e is ics o Business Owne s (2002), se en y pe cen o he owne s o employe esponden fi ms epo ed ha hei business was hei p ima y sou ce o income. The u no e o business amilies is subs an ial. En ep eneu ial income is mo e ola ile han he labo income o wo ke s. Hea on and Lucas (2000) find ha he median s anda d de ia ion o he g ow h a e o non a m p op ie a y income is 64% annually while he median s anda d de ia ion o he g ow h a e o eal wage income is only 35% annually. E ans (1987) es ima es ha he exi a e is a ound 4.5% ( he a e o en ep eneu s wi h one yea o enu e is much highe , see Quad ini (1999a)). No only ace en ep eneu s high isk in hei occupa ion, i also has a u u e alue compa ed o ini ial income: Hamil on (2000) finds e idence ha mos en ep eneu s en e and pe sis in business despi e he ac ha hey ha e lowe ini ial ea nings in paid employmen , wi h a median ea nings diffe en ial o 35 pe cen . A ailable e idence sugges s ha en ep eneu s a e cons ained by hei weal h. Based on he Na ional Longi udinal Su ey, E ans and Leigh on (1989) find ha men wi h g ea e asse s a e mo e likely o become sel -employed all else being equal. They es ima e in hei model ha en ep eneu s can bo ow up o 50% o hei cu en asse s.3The Fede al Rese e Su ey o Te ms o Business Lending 3In an impo an field s udy Paulson and Townsend (2002) find ha wo- hi ds o Thai business households a e financially cons ained, mos ly due o limi ed commi men p oblem aced by he poo en ep eneu s. 5 e eals ha small loans a e mo e o en secu ed by colla e al.4Small fi ms pay ewe di idends, ake on mo e deb , and in es mo e. In e ms o he agg ega e alue o small fi m deb , almos 90% o c edi comes om adi ional sou ces, mos ly lines o c edi and loans. Be ween 65 pe cen and 79 pe cen o en ep eneu s s a ed hei own business and almos hal o en ep eneu s use hei own o hei amily’s sa ings. Fazza i e al. (1988) epo ha in e nal finance in he o m o e ained ea nings gene a es he majo i y o ne unds o fi ms o all size ca ego ies: he a e age e en ion a io is la ges o small fi ms (80%) and lowes o he la ges fi ms (50%). Finally, Eisne (1978) finds ha he iming o in es men in small fi ms is mo e sensi i e o p ofi s han i is in la ge fi ms. A he same ime, en ep eneu ial ac i i y is a e y impo an ea u e o he U.S. economy. Small fi ms play an impo an ole in inno a ion, echnological change and p oduc i i y g ow h. Da is e al. (1996) show ha he a es o job c ea ion and job des uc ion in U.S. manu ac u ing fi ms dec ease in fi m size and ha , condi ional on he ini ial size, small fi ms g ow as e han la ge fi ms. In he 1990s, small businesses employed mo e han hal o he wo k o ce and c ea ed h ee- ou hs o he new jobs. The benchma k model in he nex Sec ion a emp s o eplica e his lis o da a on en ep eneu ial ac i i y in he Uni ed S a es. Mo i a ed by he abo e empi ical egula i ies, agen s will be iden ified by hei accumula ed le el o asse s and en ep eneu ial abili y. In he p esence o financial cons ain s, occupa ional choice and en ep eneu ial decisions will be unc ions o his indi idual s a e and equilib ium p ices. 3 The Economy In his pape we desc ibe ou economies ha diffe in financial in e media ion se ices hey p o ide. In his Sec ion we de elop he benchma k economy wi h bo owing and lending in e media ed by a compe i i e endogenous banking sec o . The e is a con inuum o agen s wi h mass one. These indi iduals diffe in he amoun o accumula ed asse s and hei alen (p oduc i i y). Each agen decides whe he o alloca e his alen o be an en ep eneu and es ablish a fi m o o be a wo ke and wo k o an en ep eneu . We assume ha he e exis s a financial 4In 2000, o all comme cial and indus ial loans in he Uni ed S a es, 83% equi ed colla e al o loans smalle han $99,000, 74% o loans smalle han $1 million, 46.9% o loans smalle han $10 million, and only 31.7% o loans g ea e han $10 million. In Eu ope, he 2010 ECB su ey o small and medium size en e p ises (SME) shows ha a ound 60% o small and medium size en e p ises (SME) use a leas one sou ce o deb financing. The mos p e alen sou ce o deb financing has been he bank: 30% o companies ha e used bank o e d a acili ies o a c edi line and 26% ha e ecei ed a bank loan. Lack o colla e al is he mos significan obs acle o es ablishing a fi m, wi h abou 15% o loans we e ully ejec ed. See De Na di e al. (2007) o a simila e idence o he Uni ed S a es. 6 in e media ion sec o ha p o ides c edi se ices. Each agen is endowed wi h a uni o ime and e alua es s eams o consump ion cwi h a u ili y unc ion E[∞ ∑ =0 β u(c )], whe e β∈(0,1) and u:ℜ+→ ℜ is a bounded, s ic ly inc easing, s ic ly conca e, and wice diffe en iable con inuous unc ion ha sa isfies he Inada condi ions. The iming o e en s is as ollows. A he beginning o e e y pe iod, agen s a e iden ified by a le el o accumula ed asse s a∈A= [0,∞) and by an idiosync a ic p oduc i i y shock z∈Z= [z,z]. This p oduc i i y le el is ca ied om he p e ious pe iod and ep esen s a signal o he effec i e p oduc i i y he agen will ha e la e in he pe iod when p oduc ion akes place, z′∈Z. Gi en aand he signal z, fi s , each agen s makes he occupa ional choice and decides whe he o become a wo ke o an en ep eneu . Wo ke s deposi hei asse s a he financial in e media ies and offe hei labo se ices in he ma ke . En ep eneu s decide how much capi al and labo o use in p oduc ion. Impo an ly, hey ha e o commi capi al and labo be o e hei effec i e p oduc i i y shock is ealized. This ea u e o he model eflec s he iskiness o en ep eneu ial occupa ion. In he li e a u e, en ep eneu s usually do no ace any isk om unning hei businesses as hei occupa ional and inpu decisions a e made a e he p oduc i i y shock is obse ed ( o example Cage i and De Na di (2006), Meh (2008), o Res uccia and Roge son (2008)). An agen who decides o be an en ep eneu and commi s his capi al and labo inpu , will d aw his p oduc i i y le el om a Ma ko p ocess wi h a mono one ansi ion unc ion Q ha sa isfies he Felle p ope y and he mixing condi ion. I an agen decides o be a wo ke , he will d aw his effec i e skill, z′, om a dis ibu ion ψ, and will ob ain labo income equal o z′wwhe e wis he equilib ium wage. A he end o he pe iod, he effec i e p oduc i i y shock o each agen z′ is ealized, p oduc ion a fi ms akes place, wo ke s a e paid hei wages and en ep eneu s ealize p ofi s o losses. Finally, each agen decides how much o consume cand he amoun o sa ings a′. The effec i e p oduc i i y shock z′is ca ied o he nex pe iod as he signal o u u e p oduc i i y shocks. All asse s dep ecia e a he a e δ∈(0,1). Banks a e in he business o in e media ing c edi . The supply o c edi comes om deposi o s, i.e. all wo ke s as well as en ep eneu s wi h asse s in excess o hei capi al needs. The demand o c edi is om en ep eneu s whose efficien size o fi m in e ms o capi al is la ge han hei accumula ed asse s. The in- e media ion echnology is ep esen ed by an agg ega e cons an - e u ns- o-scale p oduc ion unc ion ha ans o ms he deposi s o wo ke s and non-bo owing en- ep eneu s in o loans o bo owing en ep eneu s. In e media ion is cos ly as he 7 ze o-p ofi ep esen a i e bank employs capi al KLand labo NL. The equilib ium in e es a e on deposi s, D, and loans, L, will be desc ibed below. A he s a iona y equilib ium, he p oblem o an agen who en e s he pe iod wi h he pai (a, z) can be summa ized by he alue unc ion (a, z) = max {∫ W(a, z′)ψ(dz′),max k,n ∫ E(a, z′)Q(z, dz′)} i(a, z′) = max c,a′{u(c) + β (a′, z′)},(1) whe e he supe sc ip Wdeno es a wo ke and Ean en ep eneu , wi h i=W, E. No ice again ha en ep eneu s mus commi capi al and labo inpu s be o e he effec i e p oduc i i y shock z′is known. 3.1 A Wo ke ’s P oblem I an agen wi h asse s aand a signal abili y shock zdecides o be a wo ke , his budge cons ain is c+a′≤(1 −δ)a+πW(a, z′) = (1 + D)a+wz′,(2) wi h income defined as πW(a, z′)=( D+δ)a+wz′. The wo ke deposi s all his asse s a he bank o an in e es a e Dand ecei es a wage w. 3.2 An En ep eneu ’s P oblem An en ep eneu who uses capi al kand labo nand d aws an effec i e p oduc i i y shock z′, p oduces acco ding a p oduc ion unc ion y=z′ (k, n) = z′(kαn1−α)θ,(3) whe e α∈(0,1) and θ < 1. The p oduc ion unc ion exhibi s dec easing e u ns o scale which, as in Lucas (1978), can be hough o as cap u ing he p esence o dec easing e u ns o manage ial con ol. We assume hi ed labo nconsis s o a pool o pe ec ly di e sified wo ke s wi h he a e age wo ke s’ skill no malized o one. The budge cons ain o an en ep eneu is c+a′≤(1 −δ)a+π(a, z′|z),(4) whe e πis he p ofi ha depends on whe he he en ep eneu is a deposi o o a bo owe . En ep eneu s who ha e enough asse s o finance hei p ojec s a he desi ed le el wi hou bo owing om he bank, i.e. a≥k(a, z), a e ne depos- i o s and ecei e ( D+δ)(a−k) om he bank. On he o he hand, hose en- ep eneu s who need o bo ow o ob ain addi ional capi al o hei p ojec s, i.e., 8 en ep eneu s o whom k(a, z)≥a, a e ne bo owe s and mus pay ( L+δ)(k−a) o he bank. Combining he p ofi unc ions o bo h ypes o en ep eneu s, π(a, z′|z) = z′(kαn1−α)θ−wn + ( D+δ) max{0, a −k} − ( L+δ) max{0, k −a}. We assume he e is no possibili y o de aul on bank loans and wages o hi ed wo ke s. Also, we abs ac om a fixed cos associa ed wi h ope a ing a business modeled in Hopenhayn and Roge son (1993), among o he s, and hink o he endogenous oppo uni y cos o o gone equilib ium wages/p ofi s as he main de e minan o en y/exi ou comes ha a ise om compa ing he expec ed p esen discoun ed alue o each occupa ion. 3.3 The Financing Cons ain The specifica ion o he Inada- ype u ili y unc ion oge he wi h he unce ain y in en ep eneu ial p ofi s imply ha agen s wi h a low le el o accumula ed asse s may be cons ained wi h espec o he size o hei en ep eneu ial p ojec . In pa icula , he o al en ep eneu ial income mus gua an ee a nonnega i e con- sump ion o all possible ealiza ions o p ofi s. The e o e, an en ep eneu s mus ha e a sufficien le el o accumula ed asse s o sa is y he ollowing cons ain 5 (1 −δ)a+π(a, z′)≥0 o all z′∈Z. (5) Since in each pe iod Q(z, {z})>0 o all z∈Z, his ex-pos financing con- s ain mus be sa isfied o he lowes effec i e abili y shock z= 0, ha is (1 −δ)a+π(a, z)≥0. Fo en ep eneu s wi h a high signal z, ha is o hose who would like o bo ow and hi e many wo ke s, π(a, z) ep esen s a la ge loss hey mus finance om hei accumula ed asse s. This po en ial loss migh p e en hose wi h low sa ings o un a p ojec a i s efficien size. A he same ime, unning a e y small fi m migh dec ease he expec ed p ofi s below he oppo uni y cos o unning he p ojec in he fi s place.6The e o e, he financing cons ain may ha e impo an alloca ion effec s on en y and especially on he fi m size decisions. 3.4 The Financial In e media y In he benchma k economy, financial in e media ion consis s o banks ha accep deposi s and p o ide loans o en ep eneu s. Because o pe ec compe i ion in he indus y and he cons an e u ns o scale echnology o loans, banks ea n ze o 5This cons ain can also be mo i a ed by limi ed en o ceabili y o con ac s. 6The main oppo uni y cos is he o gone equilib ium wage om being a wo ke . The u u e alue o a p ojec will be discussed in Sec ion 6. 9 5 The Economy wi hou Financial In e media- ion Finally, we include a desc ip ion o an economy wi hou financial in e media ion. All agen s ha e access o a s o age echnology ha does no b ing any e u n. Each en ep eneu mus finance his o he p ojec om accumula ed asse s. O he wise, he s uc u e o he his economy is iden ical o he p e ious ones. In pa icula , he e s ill exis s a labo ma ke whe e wo ke s can be hi ed a an equilib ium wage w. En ep eneu s ha e access o he same p oduc ion echnology and asse s dep ecia e in p oduc ion a a a e δ∈(0,1). A wo ke now aces a budge cons ain c+a′≤a+wz′. An en ep eneu has a budge cons ain c+a′≤a+π(a, z′|z), wi h p ofi s equal o π(a, z′|z) = z′(kαn1−α)θ−δk −wn. Wi hou financial in e media ion, he e is a no-bo owing cons ain k≤a. The financing cons ain can be w i en, o z′=z= 0, (1 −δ)a−δ(k−a)−wn ≥0,(12) which is he same as o he benchma k economy wi h a ze o in e es a e (and diffe en equilib ium wage). The defini ion o he s a iona y ecu si e compe i i e equilib ium is simila o ha o he economy wi h financial in e media ion excep o he ma ke clea ing condi ion in he asse ma ke . I he equilib ium exis s, i.e., i he e is a posi i e ac ion o wo ke s (en ep eneu s), he o al amoun o capi al used in p oduc ion is s ic ly smalle han he o al amoun o asse s in he economy, K < A. 6 Cha ac e iza ion o En ep eneu ial Decisions The occupa ional choice o an agen is based on he compa ison o he expec ed p esen discoun ed alue o each ca ee . The ollowing wo assump ions gua an ee he exis ence o a s a iona y ecu si e equilib ium wi h a posi i e ac ion o he popula ion in each occupa ion. 16 Assump ion 1 The signal abili y shock zis such ha he e exis s an asse le el as o which ∫ W(a, z′)ψ(dz′)≤∫ E(a, z′)Q(z, dz′) o all a≥as. Assump ion 2 The signal abili y shock zis such ha ∫ W(a, z′)ψ(dz′)≥∫ E(a, z′)Q(z, dz′) o all a∈A. Bo h assump ions a e ela ed o he oppo uni y cos o each occupa ion. The fi s assump ion equi es ha he e be a shock sufficien ly high so ha agen s wi h asse s g ea e han a swi ching le el asbecome en ep eneu s: he expec ed alue o en ep eneu ship is g ea e han he expec ed alue o choosing o wo k o a wage. Vice e sa, he second assump ion equi es a shock sufficien ly low so ha agen s wi h such a signal p e e o be wo ke s. The p ope ies o alue unc ions o each occupa ion ollow he analysis in Bohacek (2006) and S okey e al. (1989). The alue unc ion o each occupa ion, I(a, z′), is s ic ly inc easing in each a gumen since he u ili y unc ion is s ic ly inc easing and s ic ly conca e and a he cons ain se is s ic ly inc easing in asse s and he effec i e abili y shock. The expec ed alue unc ion o wo ke s is independen o zand an inc easing and con inuous unc ion o a. Due o he mono onici y o he ansi ion ma ix Q, he expec ed alue unc ion o en ep eneu s is an inc easing and con inuous unc ion o bo h aand z. Finally, he alue unc ion (a, z) is non-dec easing in z and s ic ly inc easing in a.7 INSERT FIGURE 1 Figu e 1 displays alues ela ed o he occupa ional decision o agen s wi h h ee le els o signal: low, zL, medium, zM, and high, zH. As he alue unc ion o en ep eneu s is inc easing in and ha o wo ke s independen o he signal abili y shock, i can be easily shown ha o each z he e is ei he none o a mos one swi ching le el o asse s as(z) dec easing in z. Fo gi en p ices, all agen s below as(zH) a e wo ke s. Agen s wi h he high signal abili y shock swi ch o en ep eneu ship ea ly a as(zH), agen s wi h he medium signal shock a as(zM), while agen s wi h he lowes skill zLne e become en ep eneu s, ega dless o hei weal h. Thus he signal zHsa isfies Assump ion 1 and he signal zLsa isfies Assump ion 2. 7The alue unc ion (a, z)— he ou e en elope o he alue unc ions a each shock le el— may no be a conca e unc ion e en i he alue unc ions o wo ke s and en ep eneu s a e. Gomes e al. (2001) analyze a model o unemploymen wi h a simila p ope y. The ope a o on he alue unc ion sa isfies he Blackwell’s sufficien condi ions o a con ac ion mapping. In his pape , we do no explo e possible gains om andomiza ion. 17 6.1 The Fu u e Value o En ep eneu ship The expe ience aspec con ained in he mono one Ma ko p ocess has impo an implica ions o he in es men decisions o en e ing en ep eneu s. Con a y o he s a ic model in Lucas (1978), whe e agen s only conside he cu en expec ed incomes, i is he expec ed discoun ed p esen alue o each ca ee ha de e mines an agen ’s occupa ional decision. Fo a gi en le el o signal abili y shock z∈Z, an agen wi h asse s a he swi ch- ing le el as(z) is indiffe en be ween wo king and unde aking an en ep eneu ial p ojec . The e o e, i mus be he case ha ∫ W(as(z), z′)ψ(dz′) = ∫ E(as(z), z′)Q(z, dz′).(13) The fi s o de in e empo al condi ion o any asse le el aand any ealized effec- i e abili y shock z′is jus uc(c(a, z′)) = β a(a′(a, z′), z′) as he e is no unce ain y abou he agen ’s nex pe iod s a e. Using he usual en elope condi ions and as- suming in e io solu ions, he condi ion (13) can be ew i en, d opping he e m (1 + )βon bo h sides, as ∫ a(a′(as(z), z′), z′)ψ(dz′) = ∫ a(a′(as(z), z′), z′)Q(z, dz′). En ep eneu ship has a u u e alue i he ansi ion p ocess Qis sufficien ly pe - sis en , ∫z′ψ(dz′)<∫z′Q(z, dz′). In o he wo ds, he ma ginal en ep eneu s a e willing o sac ifice cu en consump ion o ha ing he oppo uni y o begin hei business ca ee ha b ings high e u ns only in he u u e. They in es a la ge sha e o hei income and weal h in o de o elax he c edi cons ain and o un hei fi m a he op imal size. Fo such agen s he expec ed cu en income om business migh be lowe han he cu en expec ed wage. Because he financing cons ain p e en s he en ep eneu om unning he fi m a he op imal size, he abo e inequali y migh hold o se e al ini ial pe iods o en ep eneu ship.8 6.2 En ep eneu ial Decisions I is easy o show ha in he h ee economies wi h financial in e media ion, all en ep eneu s use he op imal capi al-labo a io κ≡k n=(α 1−α)( w +δ) whe e equals Lo Ddepending on whe he we a e conside ing, espec i ely, a bo owing o deposi ing en ep eneu . Because L> D, deposi ing en ep eneu s un mo e capi al in ensi e fi ms han hose who bo ow. 8In he sea ch model wi h occupa ional choice by Gomes e al. (2001), consump ion o sea che s simila ly dec eases compa ed o wo ke s who keep hei jobs. 18 Because Q(z, {z})>0 o all z∈Z, he financing cons ain mus be sa isfied o he lowes effec i e abili y shock z= 0. Fo he economy wi h bo owing and lending only, he financing cons ain o a bo owing en ep eneu is (1 −δ)a−wn −( L+δ) (k−a)≥0. Using he op imal capi al-labo a io k≤α(1 + L L+δ)a. (14) This is a linea exp ession linking accumula ed asse s wi h he maximum le el o capi al sa is ying he financing cons ain . Fo he usual alues o he pa ame e s αand δand he loan a e L, α(1 + L L+δ)>1, so ha he maximum le el o capi al as a unc ion o asse s lies abo e he 45 deg ee line. Deposi ing en ep eneu s ace a simila cons ain wi h he deposi a e Dins ead o L. Howe e , as deposi ing en ep eneu s always sa is y k < a, he financing cons ain applies only o he bo owing en ep eneu s. INSERT FIGURE 2 To unde s and he ole he financing cons ain plays in he size o fi ms, Figu e 2 shows he choice o capi al o a pa icula le el o he p oduc i i y signal z. Asso- cia ed wi h his alue o he p oduc i i y signal he e a e wo uncons ained capi al le els, one o bo owing en ep eneu s, kL(a, z), and ano he one o deposi ing en ep eneu s, kD(a, z), wi h kL(a, z)< kD(a, z). The s aigh line kc(a, L) is he financing cons ain (14) which lies abo e he 45 deg ee line.9Gi en he alue o he p oduc i i y signal z, low le els o accumula ed asse s make he agen choose o be a wo ke . As we inc ease asse s we each a h eshold le el as(z) a which he agen becomes an en ep eneu . Whe he he agen s a s being financially con- s ained depends on he posi ion o he locus kc(a, L) ela i e o he le el kL(a, z) o ha pa icula le el o asse s. In his Figu e, we assume he en ep eneu is cons ained so he can only inc ease capi al along he financial cons ain . E en u- ally, he accumula es sufficien asse s and, a au(z, L), becomes an uncons ained wi h he op imal capi al le el o bo owing en ep eneu s. Main aining his op- imal capi al le el, he eaches a poin o sa ings a which he can sel -finance he p ojec , as (z, L). A e his poin , he e u n on capi al is be ween ( L+δ) and ( D+δ), and he en ep eneu con inues o sel -finance un il he s a s deposi ing a he bank. A his le el o asse s au(z, D) his fi m eaches he op imal capi al size o he gi en signal abili y shock. 9In he economies wi h isk sha ing o insu ance, his schedule will no , in gene al, be a s aigh line. 19 6.3 Financing Cons ain s In he economy wi hou financial in e media ion, he capi al-labo a io o an uncons ained en ep eneu (wi h k < a) is κu≡k n=(α 1−α)(w δ). Fo en ep eneu s who use all asse s in p oduc ion (k=a), he financing cons ain in equa ion (12) implies n≤(1−δ w)a. Tha is, en ep eneu s wi h ela i ely low le els o asse s and high skills may be cons ained in hei choices o inpu s. They will exhibi highe capi al-labo a ios han uncons ained en ep eneu s and, he e o e, la ge ma ginal p oduc- i i ies o capi al. Financial in e media ion allows hese cons ained en ep eneu s o en e and/o bo ow o expand hei fi ms. On he o he hand, uncons ained en ep eneu s wi h low ma ginal p oduc i i ies o capi al will deposi and educe hei fi ms. E en ually, gene al equilib ium effec s will p o ide incen i es o hei exi . As highe demand o inpu s inc eases equilib ium p ices, p ofi s o low skill en ep eneu s all below he oppo uni y cos o o gone cu en and u u e wages. The p oduc i i y composi ion o en ep eneu s imp o es. Simila ly, insu ance and isk sha ing alle ia es he financing cons ain o he benchma k economy. Using he ac ha only bo owing en ep eneu s a e con- s ained, ew i e he financial cons ain o he isk sha ing economy (7) o z′=z= 0, (1 −δ)a+x(1 −p)E[y(a, z′)|z]−wn −( L+δ)(k−a)≥0.(15) As ou pu ealiza ions y(a, z′) a e non-nega i e, he financing cons ain is less binding o choices x∈(0,1] i he p ice pe one uni o ans e p < 1. I he p ice is equal o g ea e han one, he op imal choice o isk sha ing is ze o. The case o insu ance con ac s is mo e complica ed as inpu decisions depend on he amoun o insu ance an en ep eneu is aking. Fo a gi en pai o (a, z) o a bo owing agen , deno e he diffe ence in he alue o inpu s χ≡[wn(a, z)+( L+δ)(k(a, z)−a)]−[wn(ˆa, z)+( L+δ)(k(ˆa, z)−ˆa)]>0, because ˆa<aand inpu s a e inc easing in a o a gi en signal z. Rew i e he financing cons ain in equa ion (11) as (1 −δ)a−wn −( L+δ)(k−a) + max {y(ˆa, z) + χ, χ} −(1 + p)∫max {0, y(ˆa, z)−ˆy(ˆa, z′|z)}Q(z, dz′)≥0, 20 whe e ˆy= ˆy(ˆa, z′|z) a e he ou pu ealiza ions a each z′and y(ˆa, z) is he ou pu le el ha co esponds o he defini ion o p ofi in a bad s a e π(ˆa, z). The financing cons ain is less binding i y(ˆa, z) + χ > (1 + p)∫max {0, y(ˆa, z)−ˆy(ˆa, z′|z)}Q(z, dz′). Again, his will be ue i he p ice o he insu ance p emium and/o he insu ance le el is no oo high. O cou se, choosing y(ˆa, z) = 0 allows he agen o a oid insu ance. Because ou pu and χa e non-nega i e, a non-ze o insu ance con ac elaxes he financing cons ain . Each alle ia ion o he financing cons ain inc eases efficiency. This is because, condi ional on a le el o weal h, en ep eneu s wi h a high skill signal zcan en e o expand hei fi ms, while gene al equilib ium effec s p o ide incen i es o low skill en ep eneu s o educe hei fi ms o exi and become wo ke s. Thus he numbe o en ep eneu s is dec easing while hei skills and size o fi ms a e inc easing in he quali y o financial ma ke s. In he nex Sec ion we show ha he wo s eady s a es wi h cos ly insu ance and isk sha ing a e much mo e efficien han he benchma k economy. 7 Quan i a i e Resul s In his Sec ion we p esen he esul s o nume ical simula ions o ou s a ion- a y equilib ia o he economy wi hou financial in e media ion, o he benchma k economy wi h bo owing and lending, and o he economies wi h financial in e - media ion combined wi h insu ance and isk sha ing. 7.1 Pa ame e s o he Model Pa ame e s o he model a e shown in Table 1 a e s anda d o he U. S. economy as in Cooley (1995). The span o manage ial con ol θse a 0.912, a le el close o he one es ima ed by Bu nside (1996). The u ili y has he loga i hmic o m. INSERT TABLE 1 ABOUT HERE The ansi ion ma ix o en ep eneu ial skills has impo an implica ions o he deg ee o business pe sis ence and accumula ion o weal h by business ami- lies. I se he alues o Qand he le els o shocks Zso ha he model is able o eplica e he fi s and second momen s o he dis ibu ion o weal h. Simila ly o Ve acie o (2001), we choose he effec i e abili y shocks o he en ep eneu s Z={0} ∪ [1, z] wi h Q({0},{0}) = 1 so ha an en ep eneu who ails wi h he lowes effec i e abili y shock will p e e o be a wo ke in he ollowing pe iod. Also, Q(z, {0})>0 o all z∈Zimplies ha all en ep eneu s e mina e hei 21 businesses in fini e ime. The en ies in he ansi ion ma ix a e calcula ed using annualized da a om Table 1 in E ans (1987) on g ow h a es and exi a es o fi ms in he Small Business Da a Base cons uc ed by he Office o Ad ocacy o he U.S. Small Business Adminis a ion (SBA). The wo ke s d aw hei effec i e abili y shocks om a fixed dis ibu ion ψwi h a lowes possible alue equal o 0.5. This specifica ion o shocks and hei laws o mo ion imposes he financing con- s ain in each pe iod and sa isfies he assump ions on he exis ence o a s a iona y equilib ium. P oduc i i y pa ame e s a e specified so ha he ou comes in he financial in e media ion economy ma ch he da a o he U.S. economy, wi h en ep eneu s cons i u ing 8% o he popula ion and he a e age exi a e is a ound 5% (see E ans (1987)). The discoun ac o and dep ecia ion a e lead o capi al-ou pu a ios equal o 3.89 in he benchma k, 3.23 in he insu ance, and 3.16 in he isk sha ing s eady s a e, espec i ely. The co esponding pa ame e s o he financial in e media ies ha e been cal- ib a ed o ma ch ce ain s a is ics o he US banking sys em. In pa icula , we we e ying o ma ch he ac ion o GDP p oduced by he financial sec o , he ac ion o capi al and labo used in ha sec o and i s capi al/ou pu a io. I is wo h no ing ha , on a e age, he financial sec o is mo e labo in ensi e han he es o he economy. While financial in e media ies use 1.3% o he capi al in he economy, hey hi e 4.2% o he labo o ce.10 The algo i hm o finding he s eady s a e o each egime is ela i ely simple. To sol e o he occupa ional decision, expec ed alues o bo h op ions a e compu ed fi s . We i e a e on he wage and he in e es a es (and insu ance paymen s) un il ma ke s a e clea ed, banks ha e ze o p ofi and he condi ions o he s a iona y ecu si e compe i i e equilib ium a e sa isfied. Finally, we se he maximal le el o asse s high enough so ha he uppe bound o he s a iona y dis ibu ion o esou ces is endogenous. The choice o isk sha ing and insu ance is exp essed as a ac ion o he ex- pec ed p ofi s o each en ep eneu , x. Fo he isk sha ing con ac , x∈[0,1] is he ac ion o p ofi s subjec o isk sha ing ans e s. Fo he insu ance con ac , x=π(a, z)/E[π(a, z′)|z], whe e π(a, z) is he choice o a p ofi le el below which he en ep eneu ecei es an insu ance ans e and E[π(a, z′)|z] is he expec ed p ofi . 7.2 S eady S a e Wi hou Financial In e media ion The agg ega e alloca ions o he economy wi hou financial in e media ion a e shown in he fi s column o Table 2. Occupa ional choice di ides he popula ion in o en ep eneu s (8%) and wo ke s (92%). As he e is no bo owing and lending, 10This da a is aken om he Fede al Rese e’s Flow o Funds Accoun s, he Bu eau o Eco- nomic Analysis Fixed Asse Tables and Employmen by Indus y. 22 only 76.9% o agg ega e asse s a e used in p oduc ion. The capi al-ou pu a io is e y high, abo e fi e. INSERT TABLE 2 ABOUT HERE Table 3 shows he dis ibu ional effec s o missing financial ma ke s on bo h occupa ions: 78% o weal h, 51% o income, and 35% o consump ion belongs o en ep eneu s. A e age en ep eneu consumes mo e han six imes han he a e - age wo ke . Co espondingly, he Gini coefficien s o weal h and income inequali y a e e y high, 0.94 and 0.51, espec i ely. The op 5% pe cen iles o agen s own 83% o weal h and ecei e 48% o income. Alloca ions o he median en ep eneu (in e ms o weal h) a e displayed in Table 4. En ep eneu s a e using almos all hei weal h in p oduc ion. Re u n on he median fi m is 12.3%. Exi om en ep eneu ship is a a e e en a an a e age a e 3.5%. While he dis ibu ion o fi ms by employmen size is domina ed by e y small fi ms (almos a hal ha e ewe han 5 employees), majo i y o wo ke s a e employed by he op decile o la ges fi ms.11 We will discuss he efficiency o hese alloca ions in compa ison wi h he o he s eady s a es. 7.3 S eady S a e Wi h Financial In e media ion Financial ma ke s affec agen s’ incen i es o accumula e capi al and p o ide access o c edi o agen s wi h low le el o accumula ed weal h. They alloca e esou ces o indi iduals whe e he e u n is g ea es , namely o po en ial and incumben en ep eneu s wi h a high signal abili y shock whose p ojec s a e p ofi able on a la ge scale han hei indi idual sa ings allow.12 The second column o Table 2 shows ha financial in e media ion allows all asse s o be used in p oduc ion. The deposi a e is 1.08% and he lending a e is 2.96%. The cos o financial in e media ion amoun s o only 2.5% o GDP, wi h a highe sha e o labo (a 4.1% due o he sec o ’s labo in ensi y). The benchma k economy wi h bo owing and lending educes he impo ance o weal h on he occupa ional decision: he a e age skill o en ep eneu s inc eases by 11.7%, he o al ac o p oduc i i y by 19.4%. Table 2 p o ides ano he measu e o efficiency, an a e age skill adjus ed capi al- o-asse a io, ΩE=∫E zk(a, z) aλ(da ×dz),(16) 11Fo a s udy o c edi cons ain s in de eloping coun ies see an impo an field s udy by Paulson and Townsend (2002) who find wo- hi ds o Thai business households financially con- s ained, mos ly due o a limi ed commi men p oblem aced by he poo en ep eneu s. 12The e is a la ge li e a u e on he impo ance o financial ma ke s o gene al economic ac i i y and economic g ow h, o example Ge le (1988), G eenwood and Jo ano ic (1990), Benci enga and Smi h (1991), King and Le ine (1993), o Le ine (1997). 23 which desc ibes he a e age quali y o capi al ela i e o a fi m’s (en ep eneu ’s) o al asse s. In e ms o his p oduc i i y measu e, bo owing and lending is 1.62 imes mo e efficien han he economy wi hou financial ma ke s. The o al ou pu inc eases by 12.5%. A ound 79% o en ep eneu s finance hei p ojec s by aking loans wi h an a e age le e age a io 0.48. As alen ma e s mo e, u no e be ween occupa ions inc eases, wi h exi a e now 4.9%, close o he da a in E ans (1987) and Da is e al. (1996). Rela i e o he economy wi hou financial in e media ion, he capi al-ou pu a io alls o 3.89. While financial in e media ion allows all asse s o be used in p oduc ion, he agg ega e s ock is now only 66% o ha in he s eady s a e wi hou financial in e media ion. These esul s sugges wo possible in e p e a ions. Fi s , financial ma ke s educe he need o accumula ion o asse s in o de o p epa e o s a ing a fi m when an en ep eneu ial oppo uni y a ises. Second, he absence o comple e insu ance ma ke s in he ace o idiosync a ic shocks leads o a p ecau iona y demand o asse s. INSERT TABLE 3 ABOUT HERE Financial in e media ion deli e s a wel a e gain o 17.5%. The main beneficia- ies o financial in e media ion a e wo ke s: G ea e compe i ion in he occupa ion ma ke inc eases wel a e o wo ke s by 41% while ha o en ep eneu s alls by 71% ( hey a e s ill much be e off han wo ke s). Compa ed o he economy wi h- ou financial ma ke s, he equilib ium wage inc eases by 43% and he e is now a posi i e e u n on sa ings. Bo h o hese ep esen highe cos s o en ep eneu s whose a e age p ofi s, wel a e, and ac ion in he popula ion all.13 A mo e efficien alloca ion o esou ces educes he en o weal h, wi h Gini inequali y measu es dec easing o 0.87 o weal h and especially due o high wages o 0.32 o income. En ep eneu s now hold only 69% o weal h and 35% o income (numbe s s ill much highe han in he U.S. economy). Occupa ional choice o he - e ogenous agen s and he in es men decisions o weal h-cons ained en ep eneu s is impo an o ma ching U.S. dis ibu ional da a. In pa icula , sa ing and in es - men decisions o en ep eneu s a e capable o gene a ing e y unequal dis ibu ion o weal h. INSERT TABLE 4 ABOUT HERE 13Sel -employmen in coun ies wi h less de eloped financial ma ke s high, o en close o 50%, mos ly in ag icul u e. Rajan and Zingales (2003) a gue and Gine and Townsend (2004) show on Thai da a ha in an economy wi h unde de eloped financial ma ke s, incumben fi ms enjoy some en s in he ma ke s hey ope a e in, bu hey also end up app op ia ing mos o he e u ns om new en u es. These en s migh be impai ed by financial de elopmen , mos ly by he en ance o new and mo e p oduc i e fi ms. This ac sugges s a plausible poli ical economy a ional o obse ed financial sec o ep ession. 24 Table 4 shows ha he median en ep eneu ’s fi m becomes la ge and p o- duces mo e han 30% highe ou pu han he median fi m in he economy wi hou financial in e media ion. The median en ep eneu has a le e age a io equal o 0.81 and e u n 7.9%. Small en ep eneu s bo ow om he banks mo e o en han la ge en ep eneu s, which is also consis en wi h he da a.14 The sha e o e y small fi ms wi h ewe han 5 wo ke s alls o 38%. 7.4 S eady S a es wi h Insu ance and Risk Sha ing Insu ance ma ke s migh be ex emely impo an o poo en ep eneu s. We an- alyze he insu ance aspec o financial ma ke s in wo sepa a e s eady s a es wi h insu ance and isk-sha ing. Recall ha he ex-an e insu ance con ac insu es a chosen ac ion o an en ep eneu ’s p ofi o a p emium paid ex-an e, be o e he ac ual shock o p oduc ion is e ealed. As he abili y o pay he p emium depends an en ep eneu ’s weal h, i only pa ially elaxes he financing cons ain . The isk sha ing con ac does no equi e a p epaid p emium: in his way, i acili a es an uncons ained en y in o en ep eneu ship. On he o he hand, i demands a ans e o unds om he en ep eneu when his p ojec is success ul. In e es a es on deposi s and loans inc ease subs an ially as asse s become mo e p oduc i e. The financial sec o is a ound 5% o GDP, abso bing be ween 6 and 7 pe cen o labo o ce. The capi al-ou pu a io alls u he o 3.23 and 3.16, espec i ely in he insu ance and isk-sha ing s eady s a es. A e age le e age is now 1.50 and 1.97. Table 3 shows ha he sha e o en ep eneu s in deposi s dec eases wi h he quali y o financial ma ke s. This means ha he e a e ewe en ep eneu s who o e accumula e asse s compa ed o hei manage ial abili ies. Bo h insu ance and isk sha ing u he inc ease he efficiency o capi al allo- ca ion: by 6% in e ms o a e age skill in en ep eneu ship e sus he benchma k financial in e media ion and 18% e sus he economy wi hou financial ma ke s. In e ms o o al ac o p oduc i i y, i is a ound 7% and 28%, espec i ely. In e ms o he skill adjus ed capi al- o-asse a io ΩEin equa ion (16), isk sha ing is 1.2 imes mo e efficien han insu ance, 2.2 imes mo e han he benchma k s eady s a e, and 3.5 imes mo e efficien han he economy wi hou financial in- e media ion. As in Moll (2010), he numbe o en ep eneu s dec eases and hei p oduc i i y inc eases wi h he quali y o financial ma ke s.15 14A ellano e al. (2009) find ha fi ms in coun ies wi h mo e de eloped financial ma ke s end o ha e la ge le e age a ios (close o 1.0) and ha he le e age-fi m size ela ion is gene ally downwa d sloping: small fi ms ha e ela i ely highe le e age a ios han la ge fi ms. In he unde de eloped coun ies, he opposi e is ue. 15OECD and Wo ld Bank su eys show ha he ac ion o sel -employed wo ke s in de eloping coun ies–whe e financial ma ke s a e also less de eloped–is much la ge han in indus ialized coun ies. These en ep eneu s ope a e a e y low inefficien le els o capi al and skills. See also Bloom and Van Reenen (2009) o a su ey o managemen p ac ices ac oss fi ms and coun ies. 25 Eisne , R. (1978). Fac o s in business in es men . Camb idge: Ballinge P ess. E osa, A. and A. Hidalgo-Cab illana (2010). 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In e na ional Economic Re iew 42(3), 571–595. 33 Pa ame e s β αEαBθ δ ZBσ 0.965 0.32 0.15 0.912 0.043 35.0 1.0 Abili y Shocks Z={z1, . . . , z8} 0 1.00 1.25 1.50 1.75 2.00 2.25 2.50 Dis ibu ion ψo Wo ke s’ Abili y Shocks 0.10 0.70 0.08 0.06 0.03 0.02 0.01 0 T ansi ion Ma ix Q o En ep eneu s’ Abili y Shocks 10000000 0.109 0.698 0.192 0.001 0 0 0 0 0.059 0.095 0.713 0.131 0.002 0 0 0 0.053 0.001 0.111 0.736 0.098 0.001 0 0 0.044 0.004 0.015 0.107 0.755 0.074 0.001 0 0.039 0 0 0.001 0.162 0.756 0.041 0.001 0.025 0 0 0 0.008 0.172 0.758 0.037 0.018 0 0 0 0 0.001 0.339 0.642 No es: Wo ke s’ lowes abili y shock z1= 0.5. Table 1: Pa ame e s o he model. 34 S eady S a es Financial In e media ion A e age No F.I. Benchma k Insu ance Risk Sha ing En ep eneu s 8.0% 7.8% 6.6% 6.5% Asse s 6.90 4.56 3.79 3.65 Capi al P oduc ion 5.31 4.44 3.67 3.52 Financial — 0.12 0.12 0.13 Ou pu 1.04 1.17 1.19 1.17 Wel a e 0.80 0.94 0.97 0.96 Equilib ium P ices Wage w1.03 1.47 1.59 1.59 Deposi Ra e D— 1.08 2.57 2.78 Loan Ra e L— 2.96 4.88 5.06 P ice o Insu ance p— — 0.10 0.11 Capi al-Ou pu 5.09 3.89 3.23 3.16 Le e age — 0.48 1.50 1.97 Insu ance/Asse s — — 0.02 0.06 Insu ance/Income — — 0.08 0.34 Bo owe s (%) — 79.3 74.6 77.1 Spell 26.1 20.6 13.0 12.8 Exi Ra e 4.1% 4.9% 8.2% 8.2% Efficiency A e age En . Skills 1.79 2.00 2.12 2.12 TFP 1.29 1.54 1.64 1.65 Capi al Skill / Asse s∗1.78 2.90 5.26 6.29 Sha e o he Financial In e media ion Sec o ∗∗ Capi al — 0.020 0.032 0.036 Labo — 0.041 0.064 0.070 Ou pu — 0.025 0.047 0.054 No es: ‘No F.I.’ is he s eady s a e wi hou financial in e media ion. Ou pu in he goods sec o only. ∗Capi al Skill / Asse s is defined as he p oduc o en ep eneu ial skill and capi al in p oduc ion di ided by asse s held by he en ep eneu . ∗∗Includes he insu ance sec o ( he sha e o insu ance in GDP is less han one pe cen , 0.004, he sha e o isk sha ing is 0.006). Table 2: S eady s a es. 35 Dis ibu ion and En ep eneu s Financial In e media ion A e age No F.I. Benchma k Insu ance Risk Sha ing Wel a e 0.80 0.94 0.97 0.96 Wo ke s 0.56 0.79 0.90 0.90 En ep eneu s 3.58 2.51 1.96 1.77 Gini Measu e o Inequali y Weal h 0.94 0.87 0.81 0.77 Income 0.51 0.32 0.25 0.23 Asse Pe cen iles Top 1% 0.44 0.32 0.23 0.20 Top 5% 0.83 0.70 0.59 0.53 Top 10% 0.96 0.85 0.76 0.70 Top 20% 0.98 0.93 0.86 0.82 Top 40% 0.99 0.95 0.93 0.91 Income Pe cen iles Top 1% 0.25 0.13 0.08 0.07 Top 5% 0.48 0.30 0.21 0.19 Top 10% 0.56 0.39 0.30 0.28 Top 20% 0.68 0.47 0.40 0.39 Top 40% 0.87 0.83 0.56 0.56 En ep eneu s Sha e in To al Asse s 0.78 0.69 0.40 0.33 Income 0.51 0.35 0.21 0.19 Consump ion 0.35 0.23 0.13 0.12 Deposi s — 0.12 0.05 0.04 No es: ‘No F.I.’ is he s eady s a e wi hou financial in e media ion. Table 3: Dis ibu ion and En ep eneu s. 36 Median En ep eneu Financial In e media ion Median No F.I. Benchma k Insu ance Risk Sha ing Asse s 30.1 19.6 13.7 9.7 Capi al 30.0 35.5 52.8 59.7 Labo 5.2 7.3 13.0 15.0 Ou pu 6.3 9.4 16.6 19.4 P ofi 3.7 2.9 2.8 2.8 Re u n 12.3% 7.9% 5.3% 4.7% Capi al-Ou pu 4.76 3.78 3.18 3.08 Le e age — 0.81 2.85 5.15 Insu ance/Asse s — — 0.02 0.13 Insu ance/P ofi — — 0.11 0.47 Spell 18.4 14.2 8.3 8.2 Exi Ra e 3.5% 5.3% 8.6% 8.6% No es: Median en ep eneu in e ms o weal h. ‘No F.I.’ is he s eady s a e wi hou financial in e media ion. Table 4: Median En ep eneu . 37 as(zH)as(zM) ∫ E(a, z′)Q(zH, dz′) ∫ E(a, z′)Q(zM, dz′) ∫ W(a, z′)ψ(dz′) ∫ E(a, z′)Q(zL, dz′) a Figu e 1: Value unc ions o en ep eneu s and wo ke s. 38 (a,z) (a,z) a k kc(a, L)45º k(a,z) as(z)au(z, L)as (z)au(z, D) Figu e 2: Policy unc ion o capi al alloca ion as a unc ion o weal h and skill. 39 101102103 101 102 103A e age Capi al in P oduc ion log(Weal h) log(k) Risk Sha ing Insu ance Benchma k No Fin. In . Figu e 3: A e age capi al in p oduc ion as a unc ion o en ep eneu ial weal h. Do s ep esen deciles o he en ep eneu ial dis ibu ion o weal h (1s , 2nd, ...) wi h he las ou do s deno ing he 90 h, 95 h, 99 h, and 100 h pe cen ile, espec- i ely. 40 101102 101 102 Insu ance: A e age Capi al in P oduc ion z8 z7 z6 log(k) 101102 101 102 Risk Sha ing: A e age Capi al in P oduc ion z8 z7 z6 log(Weal h) log(k) Figu e 4: Capi al in p oduc ion o diffe en p oduc i i y signals zas a unc ion o en ep eneu ial weal h. The do s ep esen deciles o he en ep eneu ial dis i- bu ion o weal h (1s , 2nd, ...) wi h he las ou do s deno ing he 90 h, 95 h, 99 h, and 100 h pe cen ile, espec i ely. 41