The Labor Market, the Decision to Become an Entrepreneur, and the Firm Size Distribution

Markus Poschke

Cahiers de recherche from Centre interuniversitaire de recherche en économie quantitative, CIREQ

Abstract: Why do some people become entrepreneurs, how do institutions affect this choice, and how does this affect the firm size distribution and aggregate productivity? This paper addresses this question using a matching model with occupational choice and heterogeneity in both ability as a worker and ex ante unknown productivity of firm start-ups. This rich setting allows to address effects of heterogeneity and diverse types of institutions, like labor market institutions, entry restrictions, taxes, which can possibly differ by firm size and thereby allow addressing informality. Importantly, the model allows for a comparatively flexible lower tail of the firm size distribution and can explain the existence and persistence of small, low-productivity firms with low profits: their owners have low outside options in the labor market. Key effects from a preliminary analysis are the following: labor market conditions affect incentives to start firms differently for workers and the unemployed, with repercussions on aggregate productivity; and they affect the expected value of firm creation due to the possibility of failure. Labor market frictions can have a new effect here: they shape prospective entrepreneurs' value of failure. Given that failure of new projects is common, they can strongly affect not only entry rates, but also the type of firms that enter.

Keywords: Occupational choice; firm entry; self-employment; matching models; selection; firm size distribution. (search for similar items in EconPapers)
JEL-codes: E24 J23 J62 J64 (search for similar items in EconPapers)
Pages: 33 pages
Date: 2012
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (4)

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