STEG Working Paper

Skill Bias, Financial Frictions, and Selection into Entrepreneurship

Ying Feng and Jie Ren

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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.

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