|
...monopolistic competition, employment ordinary worker in this sector. Entrepreneurial profits are stochastic. The occupational choice under risk endogenizes the number of firms in the intermediate goods industry. While the presence of entrepreneurial risk results in a suboptimally low number of firms and depresses growth, nonlinear tax schemes can sometimes compensate negative effects by ex post providing social insurance.
Keywords: OLG, endogenous growth, entrepreneurship, occupational choice, redistribution.
JEL Classification: D31, E62, O41, P16, J21.
1 Introduction
This paper investigates the effects of redistributive taxation on occupational choice and long-run growth. The analysis combines the issue of occupational choice under risk in the tradition of Kihlstrom and Laffont (1979) and Kanbur (1979a, b; 1980) with modern approaches to endogenous growth a la Romer (1990) or Grossman and Helpman (1991) in the framework of a macroeconomic overlapping generations model. The paper thus adopts the Knightian view on the role of entrepreneurship (Knight, 1921), considering risk-bearing to be an essential task of entrepreneurs.
In the model suggested here, the long-run growth rate of the economy is positively correlated with the population share of entrepreneurs. This reflects recent empirical observations by Audretsch and Thurik (2000), Audretsch et al. (2002) as well as Carree et al. (2002),who find for a cross section of 23 OECD countries that entrepreneurship is a vital determinant for economic growth.
The agents engage in one of two alternative occupations: Either they set up a firm in a market of monopolistic competition, which exposes them to a non-diversifiable profit risk. Or they decide to be a worker in this sector, thereby earning a safe wage income. Non-surprisingly, the attitude towards risk turns out to play a central role for the extent of entrepreneurial risk-taking, a finding which is empirically supported by Cramer et al. (2002), and Ilmakunnas et al. (1999).
We identify two counteracting forces. On the one hand, the prospect of yielding monopoly profits provides an incentive to set up a firm. On the other hand, risk averse agents are concerned with avoiding the income risks being associated with self-employment. The market equilibrium is characterized by a suboptimally low number of firms in the intermediate goods sector. This carries over to the long-run growth rate of the economy, which is a function of the population share of entrepreneurs. Hence, our approach provides an explanation for the empirically documented negative relationship between risk and growth (Ramey and Ramey, 1995).
The riskiness of self-employment is also expressed in high failure rates of entrepreneurial ventures (cf. Quadrini, 1999). According to U. S. data from the Panel Study of Income Dynamics (PSID), first year exit rates amount to 35%. Heaton and Lucas (2000) point out that the incomes of entrepreneurs exhibit a considerably higher volatility than wage incomes, although evidence on the return to private (entrepreneurial) equity relative to public equity hardly indicates the presence of a positive risk premium; see also Moskowitz and Vissing-Jorgensen (2002). Germany experienced an ongoing growth in business failures throughout the last decade, in absolute numbers from about 11,000 in 1992 to 40,000 in 2004. Recent data from the German "Bundesagentur fur Arbeit" reveal that about one fifth of the participants in the public program subsidizing small start-up enterprises ("Ich-AG") left the market within the first two years.
If the presence of risk goes along with less entrepreneurial activity and subsequently lower growth, a natural question to ask is to what extent an appropriately designed public tax-transfer-scheme might stimulate firm ownership, if private markets for pooling individual risks are not available due to credit market imperfections or moral hazard problems. These considerations draw from an argument first brought forward by Varian (1980), Eaton and Rosen (1980) and Sinn (1996). The authors point out that redistributive taxation--being effective ex post--acts as a social insurance, thereby providing incentives to already increase risk-taking from an ex ante point of view.
Carried over to the context discussed here, the argument suggests that an increase in redistribution causes a rise in the number of agents choosing to be an entrepreneur, hence ultimately promoting growth, although the ex ante extent of income inequality becomes larger too. Our subsequent analysis makes explicit the conditions under which this line of argument yields the desired results and when it fails to do so. We demonstrate that the implementation of a progressive tax-transfer-scheme is Pareto-improving if the society is sufficiently risk averse. The redistributive scheme which maximizes social welfare for a comparably low degree of risk aversion can be either progressive or regressive, but never constitutes a Pareto-improvement, as early generations get harmed and do not receive compensation payments for their welfare losses.
The important role which entrepreneurial risk might play for long-run growth has been of little interest, when we review the development of modern growth theory throughout the last two decades. Authors like Romer (1990), Grossman and Helpman (1991), or Aghion and Howitt (1992) emphasize the Schumpeterian view on entrepreneurship. The contributions stress the innovative potential of firm ownership by focusing on R & D efforts and associated monopoly profits due to exclusive property rights. But even if innovations are considered to follow random processes, those firms undertaking research are usually assumed to be indifferent towards risk.
A notably exception is the contribution of Garcia Penalosa and Wen (2004) who, similar to Clemens (2004), establish a causality between individual income risk, entrepreneurship, and growth. Garcia Penalosa and Wen (2004) focus on the riskiness of innovations in the R & D sector, yet, at the cost of not taking into account the intertemporal savings decision and the accumulation of physical capital. In our model, occupational choice affects the long-run growth rate of the economy via the equilibrium rate of return to capital. This enables us to derive more general results regarding the growth and welfare effects of redistribution.
The paper is organized as follows: the overlapping generations general equilibrium model is developed in the next section, which also characterizes optimal individual behavior of households and firms in the intermediate as well as in the final goods sector. Section 3 introduces the nonlinear redistributive tax-transfer-scheme and also describes the equilibrium occupational choice under risk. Section 4 determines the market equilibrium and the long-run growth rate of the economy. We examine the growth and welfare effects of changes in the amount of redistribution due to changes in the degree of tax progression.
2 The Model
2.1 Households
We consider a discrete-time overlapping generations economy in the tradition of Samuelson (1958), or Diamond (1965). The identical households live for two periods. We normalize the population size of each cohort to unity. There is no population growth. Each member of the young generation is endowed with one unit of labor, which he supplies inelastically. At the beginning of their life, citizens choose between two alternative types of occupation. They can decide either to set up a firm and become a monopolistic entrepreneur in the intermediate goods industry, or they become employed in this sector. [[lambda].sub.t] denotes the share of entrepreneurs within the generation which is active in period t. The corresponding share of workers is given by 1 - [[lambda].sub.t].
While employment is payed the riskless wage income w, self-employment yields risky profits [[pi].sub.j] per monopoly j. The risk stems from an idiosyncratic technology shock. By the time the households choose between the occupations, they do not know the realization of the shock.
By the time they compose their intertemporal consumption profile, the income realization is known and the agents act under perfect foresight. We assume the costs of switching between occupations to be prohibitively high, such that the employment decision once made is irreversible. All individuals retire after the first period. When old, savings and interest payments are used to finance retirement consumption. There...
NOTE: All illustrations and photos
have been removed from this article.
More articles from Journal of Economics
Management ability, long-run growth, and poverty traps., October 01, 2006
A note on ad valorem and per unit taxation in an oligopoly model., October 01, 2006
Looking for additional articles?
Search our database of over 3 million articles.
Looking for more in-depth information on this industry?
Search our complete database of Industry & Market reports by text, subject, publication
name or publication date.
About Goliath
Whether you're looking for sales prospects, competitive information, company
analysis or best practices in managing your organization,
Goliath can help you meet your business needs.
Our extensive business information databases empower business
professionals with both the breadth and depth of credible,
authoritative information they need to support their business
goals. Whether it be strategic planning, sales prospecting,
company research or defining management best practices -
Goliath is your leading source for accurate information.
|
