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STEG Working Paper

Skill Bias, Financial Frictions, and Selection into Entrepreneurship

Ying Feng and Jie Ren

Financial frictions adversely affect productivity by discouraging entrepreneurship, which is often measured by the self-employed. This paper distinguishes different types of self-employment when studying this question. Using micro data for 77 countries from all income levels, we show that employers' labor shares are increasing with GDP per capita, whereas own-account employment (self-employed without employees) is decreasing. We also find an almost universally negative selection on education into own-account status relative to wage workers and positive selection into employers. To quantitatively match these facts, we introduce skill-biased productivity progress across countries in an occupationalchoice model with financial frictions. Our model predicts an average of 19% output gains in low-income countries from removing financial frictions. In contrast, an alternative model with skill-neutral technological change cannot match the high own-account employment share in low-income countries, thus overestimating the output gains by 13 percentage points.