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Fewer, Bigger Entrepreneurs Explains Rising Inequality

Summary:
Why has wealth inequality increased in the United States? A lot of semi-plausible but vague theories have been offered–changes in the tax code, the diminished role of unions and so forth–but there are surprisingly few fully-specified models. In an important paper, Mohsen Mohaghegh (on the job market) has a new answer. Wealth inequality has risen considerably in the US since 1975. For instance, the wealth share of households in the top 1 percent of the distribution rose from 25 percent in 1975 to more than 37 percent in 2007. This paper builds on theories of entrepreneurship and wealth inequality to address changes in inequality in the US between 1975 and 2007. In the data, there are two trends in entrepreneurship since 1975: the average debt-to-asset ratio among entrepreneurs has

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Why has wealth inequality increased in the United States? A lot of semi-plausible but vague theories have been offered–changes in the tax code, the diminished role of unions and so forth–but there are surprisingly few fully-specified models. In an important paper, Mohsen Mohaghegh (on the job market) has a new answer.

Wealth inequality has risen considerably in the US since 1975. For instance, the wealth share of households in the top 1 percent of the distribution rose from 25 percent in 1975 to more than 37 percent in 2007. This paper builds on theories of entrepreneurship and wealth inequality to address changes in inequality in the US between 1975 and 2007.

In the data, there are two trends in entrepreneurship since 1975: the average debt-to-asset ratio among entrepreneurs has increased, and the number of entrepreneurs (the entrepreneurship rate) has fallen. I study how the distribution of wealth changes over time, when these two trends are accounted for in a model.

…[two] channels accounts for both the fall in the entrepreneurship rate and the rise in the entrepreneurs’ leverage: an increase in banks’ willingness to fund risky entrepreneurial projects and a rise in the costs of starting a business. When changes in entrepreneurship are accounted for, my model explains more than 90 percent of the rise in the share of wealth held by the top 1 percent of households, and just under half of the rise in the share of the top 0.01 percent of households in the data.

A lower rate of entrepreneurship implies that a smaller number of households can take advantage of their productive ideas. Active entrepreneurs, however, have access to more capital which allows highly productive entrepreneurs to expand their businesses. Both of these changes contribute to a rise in inequality over time.

Below are two figures from the paper showing the declining entrepreneurship rate and increasing leverage. Mohaghegh doesn’t explain these facts but he connects three literatures, declining entrepreneurship, increasing financialization and rising inequality and he shows that the first two of these well-known features of the US economy can explain a large share of the third, the rise in inequality.

Fewer, Bigger Entrepreneurs Explains Rising Inequality

The post Fewer, Bigger Entrepreneurs Explains Rising Inequality appeared first on Marginal REVOLUTION.

Alex Tabarrok
Alex Tabarrok is Bartley J. Madden Chair in Economics at the Mercatus Center at George Mason University and a professor of economics at George Mason University. He specializes in patent-system reform, the effectiveness of bounty hunters compared to the police, how judicial elections bias judges, and how local poverty rates impact trial decisions by juries. He also examines methods for increasing the supply of human organs for transplant, the regulation of pharmaceuticals by the FDA, and voting systems.

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