How Does Middle-Class Financial Health Affect Entrepreneurship in America?

8/21/2019 How Does Middle-Class Financial Health Affect Entrepreneurship in America?

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How Does Middle-ClassFinancial Health Affect

Entrepreneurship in America?By Camilo Mondragón-Vélez,

International Finance Corporation, World Bank Group May 2015


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How Does Middle-ClassFinancial Health AffectEntrepreneurship in America?

By Camilo Mondragón-Vélez,

International Finance Corporation, World Bank Group May 2015

The views expressed in this paper belong to the author and do not necessarilyrepresent those of the IFC, IFC management, or the World Bank Group.


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1 Introduction and summary

4 Why inequality matters for the entrepreneur economy

9 How business ownership in the United States

has evolved since the late 1960s

14 The financial health of the middle class

and inequality in the United States

19 Entrepreneurship trends in the United States

24 Conclusion

27 Appendix A: Methodology

28 Appendix B: Comparing the Panel Study ofIncome Dynamics and the Survey of Consumer Finances

30 About the author

31 Acknowledgements & References

32 Endnotes

Contents


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1 Center for American Progress | How Does Middle-Class Financial Health Affect Entrepreneurship in America?

Introduction and summary

Enrepreneurs play a criical role in he U.S. economy, and

America’s middle class plays a criical role in nururing he peo-

ple and social environmen ha creae successul enrepreneurs.

In oher words, he dynamics o business creaion and consolida-

ion are inerlinked wih hose o overall economic growh and

he financial healh o middle-class amilies.

o become an enrepreneur, afer all, is ofen a amily deci-sionweighing he poenial risks agains he probable rewards

and dedicaing significan porions o a amily’s income, wealh,

human capial, and effor ino a business venure. Analysis in his

repor shows ha middle-class amilies accoun or 60 percen

o new business venures. According o he U.S. Small Business Adminisraion,

small firmsdefined as hose wih up o 500 employeesrepresen more han 99

percen o employer firms, generae hal o non-arm privae goods and services in

he U.S. economy, employ abou hal o all privae-secor workers, and have cre-

aed around wo-hirds o ne new jobs in he pas wo decades.3

I is worh noing, however, ha here is an acive debae abou he relaionship

beween job creaion and firm size. Proessor John Haliwanger and he co-

auhors o he 2013 sudy “Who Creaes Jobs? Small vs. Large vs. Young” show

ha when firm age is included in he analysis o job creaion and firm size, i is no

possible o draw any definie conclusion abou he relaionship beween firm size

and employmen growh. More imporanly or he purpose o his sudy, heir

findings sugges ha “business sarups conribue subsanially o boh gross and

ne job creaion,” and hey find “an ‘up or ou’ dynamic o young firms”ha is,

young firms eiher grow o survive or are ou o business.4

Increased financial sress on middle-class amiliesrelaed o rising income and

wealh inequaliyis unorunaely consraining he creaion o new businesses

in he U.S. economy and hereore huring overall economic growh and job

This report analyzes data from the Panel St

of Income Dynamics to understand the effe

inequality and the financial health of the m

class on the dynamics of business creation

entrepreneurs in the United States.1 For the

purposes of analysis in this report, “middle

is defined as households with total family i

between $41,000 and $151,000, or betwee

the 40th percentile and 90th percentile of

income distribution.2


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creaion. Economic expansion in he medium and long run should be refleced

in increasing numbers o consolidaed and growing privae-secor firms, which is

suppored by a dynamic process o business creaion.5 Tis was he case or he

U.S. economy rom he 1970s hrough he 1990s, a period when gross domes-

ic produche measure o all goods and services produced by an economy’s

workers and equipmengrew by more han 80 percen in real erms, while hepercenage o business-owner amiliesdefined as hose where a leas one amily

member is a business ownerincreased rom less han 10 percen o abou 13.5

percen, according o analysis presened in his repor.6 Bu as middle-class ami-

lies’ income sagnaed, especially in he business-cycle expansion o he 2000s,

he average percenage o business-owner households dropped o 12.4 percen

rom 2002 o 2008 and again o 11.8 percen in 2010. Te ne effec is equivalen

o a loss o more han 1 million business-owner households in he Unied Saes

compared o he previous decade.7

Te decline in business ownership rom 2002 o he financial crisis in 2010resuled rom salling business creaion raeshe percenage o households

becoming business owners wihin one daa collecion periodand increasing

raes o business ailure.8 Te rae o new business ownership among American

amilies increased rom 3 percen in he 1970s o 5 percen in he lae 1990s bu

remained below his level in he 2000s. In conras, business ailureha is,

he rae a which business-owner amilies close heir businesses wihin one daa

collecion periodinched oward 30 percen since he lae 1990s afer flucua-

ing beween 20 percen and 25 percen or mos o he previous hree decades,

according o daa presened in his repor.

A more qualiaive view o he middle class includes hose wih sufficien incomes

and insulaion rom economic risks and he abiliy and means o make long-

sighed decisions o inves in opporuniies or hemselves and or he nex gen-

eraion. Regardless o how one delineaes “middle class,” he evidence indicaes

ha as he Unied Saes has grown more unequal, he opporuniy o become

an enrepreneur has moved arher ou o reach or many people. Te analysis

presened in his repor finds:

• Middle-class amilies accoun or 60 percen o new business-owner householdsin he Unied Saes in he pas our decades, and heir increasing financial sress

parly explains he sagnaion o business-creaion raes in he 2000s compared

o he lae 1990s.


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• Beore saring heir businesses, new business owners in he 2000s had wo

o hree imes more wealh han heir median worker peers. In he 1980s and

1990s, however, new business owners only had 1.7 o 2 imes more wealh han

heir median worker peers.

•New enrepreneurs in he 2000s on average waied an addiional seven years beore becoming business owners, compared o he 1980s.

Moreover, hrough he well-known effecs o inequaliy on opporuniies or qualiy

educaion in he Unied Saes, he abiliies and alens o many poenial enrepre-

neurs remain undeveloped. Educaion no only plays a criical role in he develop-

men o producive peopleworkers and enrepreneurs alikebu also plays a role

in reducing he inequaliy o income and opporuniies, which can be ransmited

hrough ime o subsequen generaions o descendans.9 In ac, his repor shows

ha he racion o new business owners wih more han a high school educaion

increased rom 50 percen in he 1970s o 67 percen in he 2000s and 75 percenin 2010. Overall, abou wo-hirds o new business owners in he pas decade have

some college educaion, relaive o less han 60 percen beween he 1970s and he

mid-1980s and around 60 percen during he 1990s and he early 2000s.

Te link beween enrepreneurship and educaion implies ha he opporuniy o

enrepreneurship has become more concenraed among hose wih higher educa-

ion a a ime when rising inequaliy ighens educaional consrains, hereby

puting he choice o enrepreneurship ou o some people’s reach. Furhermore,

resriced access o enrepreneurship consrains upward social mobiliy opporu-

niies or middle-class amilies across he Unied Saes.10

Business creaion is hereore closely relaed o he financial healh o he middle

class. In his regard, he acs documened in his repor sugges ha he sruc-

ural policies ha have led o unequal economic oucomes and opporuniies or

American amilies over he pas decades are in ac inhibiing he developmen o

he criical enrepreneurial secor o he U.S. economy. Furhermore, he evidence

presened below suggess ha macroeconomic and srucural policies direced

oward increasing educaion opporuniies, as well as income adjused or infla-

ion, o broaden and srenghen he U.S. middle class will allow hese householdso make beter choices abou saring new businesses. Tis will resul in a more

efficien and innovaive populaion o enrepreneurs. In sum, policies ocused

on srenghening he financial healh o he middle class will ulimaely oser a

vibran and dynamic enrepreneurial economy in he Unied Saes.11


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Why inequality matters for

the entrepreneur economy

A number o acors influence an individual’s decision o become an enrepreneur.

One migh hink ha i all sars rom having or coming up wih a business idea ha

could be developed ino a financially atraciveor a leas susainableoperaion.

Along hese lines, he expeced financial reurns o he new venure would be basi-

cally driven by various elemens inheren o he paricular business projec, includ-

ing marke size, compeiion, and expeced revenues over ime; operaional coss

and echnology; firm size and required invesmens; as well as he risks and uncer-

ainies relaed o each o hese. Even beore a business idea sars o be developedor he acual decision o sar a new firm is made, however, here are idiosyncraic

characerisics ha will deermine i some individuals will even consider looking

or business ideas; he indusry secors, business lines, and echnologies hey will

consider; he invesmen program hey will be able o und; as well as he decision

o direcly managing he new business or hiring ohers o do so. Some o he key

individual characerisics sudied in he academic lieraure are:

• Unobservable enrepreneurial verve and abiliy • olerance or risk aking• Observable human capial• Accumulaed wealh

Te remainder o his secion briefly discusses he role or roles ha each o hese

characerisics plays in he individual’s decision o become an enrepreneur.

Unobservable entrepreneurial verve and ability

No everyone has he desire or willingness o become an enrepreneur. Whileor some individuals, he real deerren migh be he ear o ake risks, ohers are

no willing o go hrough he sruggles o business ownership aside rom risk and

uncerainy, which include dealing wih cliens, suppliers, and employees, and in

many cases, working long hours. Hence, here is a racion o he populaion ha

will never become enrepreneurs, no mater how good heir business idea seems.


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Furhermore, he degree o enrepreneurial verve o hose willing o consider busi-

ness ownership serves as a filer on he ypes o business venures in which specific

individuals are eiher willing or unwilling o engage. In many cases, his degree

o willingness is relaed o he expeced financial benefis associaed wih he

business, alhough panel daa sudies show ha financial rewards are one among

a range o leading moives expressed by nascen enrepreneurs. Business scholarNancy Carer and co-auhors ound ha enrepreneurs expressed values or he

sel-realizaion, ideniy roles, innovaion, recogniion, and independence associ-

aed wih enrepreneurshipin addiion o financial successin making heir

career choice. In oher words, wo individuals wih differen degrees o enrepre-

neurial spiri may make a differen decision abou he same business opporuniy.

On he oher hand, one can disinguish enrepreneurial verve, such as desire,

spiri, or willingness, rom abiliy, such as managemen, markeing, operaional,

and commercial skills. While high willingness o sar a business does no neces-

sarily improve he chances o success, enrepreneurial abiliies are a criical com-ponen o business success and growh. In ac, managemen scholars highligh

he imporance o social capialabiliies reflecing inerpersonal and emoional

inelligenceor enrepreneurial success. As wih enrepreneurial verve, business

skills are disribued hroughou he populaion a varying degrees. Tereore, wo

individuals wih differen enrepreneurial skill ses will mos likely have differen

resuls saring he same kind o business under similar marke and economic con-

diions. Moreover, a poenial enrepreneur wih high business abiliy will mos

likely come up wih beter and more atracive business opporuniies.12

Enrepreneurial spiri and abiliy are difficul o assess. While he ormer can be

surveyed ex-ane, i is only when individuals make he decision o become enre-

preneurs ha i is effecively revealed.13 Wih regard o he later, here is exensive

lieraure in economics and psychology ha ries o esablish he characerisics

ha drive successul enrepreneurship. All in all, here is no a generalized consen-

sus in his regard.14

Tolerance for risk taking

Saring a firm involves aking risks. Enrepreneurs can no only lose he financial

capial invesed in he new business bu can also lose he personal effor and hard

work hey pu ino he business as well. On he oher hand, he degree o risk ol-

erance varies wih each individual, jus as enrepreneurial verve and abiliy varies.

Some people will hereore be comorable invesing in cerain ypes o high-risk

proposiions, while oher people simply will no consider hem.


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Economiss have long sudied he role ha atiudes oward risk have in economic

decisions. Tis lieraure is buil on he premise ha risk olerance is a criical ele-

men ha shapes individuals’ preerences when acing a decision, such as consuming

more oday versus omorrow, buying insurance, and invesing in he sock marke.15

Risk oleranceas enrepreneurial verve and abiliyis no easy o measure.Economic models ha invesigae individual behavior usually assess how people’s

willingness o ake on financial risks differs across he populaion, including

wheher o underake he risks o sel-employmen. Many recen advances in

economic and inerdisciplinary behavioral research lend insigh o researchers’

abiliy o observe and measure individuals’ decision-making and olerance or risk

in experimenal setings.16 Alhough a number o observable economic and demo-

graphic characerisicssuch as wealh, educaion, age, race and ehniciy, and

access o healh insurancecan predic someone’s choice o become an enrepre-

neur, he more difficul-o-observe individual preerence or a paricular level o

risk is also a significan deerminan o wheher someone sars a business.17

Observable human capital

Te main componens o observable human capial are an individual’s level o

ormal educaion and years o working experience. More disaggregaed defini-

ions could also consider he qualiy and line o educaion acquiredbusiness

versus law versus medicine, or exampleas well as he years o experience as a

paid worker versus hose as an enrepreneur, he lines o business, and he ype o

occupaion held in each o hese. o keep he analysis simple, I will briefly discuss

he role o educaion and experience on a more generic basis.

Educaion plays a crucial role in enrepreneurship. Mos empirical sudies show

ha a majoriy o enrepreneurs have higher levels o educaion, meaning a leas

some college.18 In oher words, higher educaion increases he chances o becom-

ing an enrepreneur. Tis may be due o he ac ha educaion provides a broader

scope or individuals wih regard o heir opions or because educaion provides

beter neworks o come up wih ideas, as well as poenial business parners. In

addiion, educaion plays a role in he ype o business ha enrepreneurs sarand run. I is, or example, hard o find a medical pracice business no owned by

docors and a law firm run by an individual wihou a law degree.19 Te empirical

evidence or he Unied Saes also shows how business income rom enrepre-

neurs wih higher educaion is on average higher han business income rom hose

wih lower levels o educaion.20


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Experienceusually measured by years o work experience or proxied by ageis

also hough o increase one’s chances o becoming an enrepreneur. Te mos

common view is ha acquired knowledge o specific markes and secors provide

poenial enrepreneurs wih srong ools o ideniy business opporuniies, as

well as neworks o sar heir business in a specific indusry.21

Moreover, boh educaion and experience play a role in deermining paid work

wages, which are a criical benchmark o which poenial enrepreneurs compare

heir expeced financial benefis o becoming business owners. In oher words,

highly paid salaried workers will require a much beter business prospec o ener

enrepreneurship. Given is double role on he benefis, as well as he opporuniy

cos side wihin he decision o sar a business, he ne effec o human capial

canno be easily pinned down.22

Accumulated wealth

An imporan srand o he academic lieraure on enrepreneurship and occupa-

ional choice ocuses on access o finance or exising and poenial enrepreneurs.

In his regard, he early consensus around he acive role o financial consrains in

deermining occupaional choice was buil upon he seminal sudies o Proessors

David Evans, Linda Leighon, and Boyan Jovanovich, who documened a posiive

relaionship beween wealh and he probabiliy o becoming an enrepreneur.

Tis linkage implies ha poenial enrepreneurs increase heir chances o saring

new businesses when hey have more wealh, which can be used as seed capial or

loan collaeral o sar heir new venure.23

Tis resul was challenged by Proessors Erik Hurs and Annamaria Lusardi, who

showed ha he aggregae probabiliy o saring a business in he Unied Saes

is fla up o he 90h percenile o he wealh disribuion, afer which i increases

wih wealh. In oher words, he chance o become a business owner is basically

he same or he majoriy o salaried workers, regardless o heir accumulaed

wealh. Along hese lines, Hurs and Lusardi inerpreed his finding as evidence

o he lack o srong liquidiy or financing consrains or mos Americans o

sar heir own business, which would ulimaely imply ha he lack o seedcapial is no a significan deerren or poenial enrepreneurs o sar new firms

in he Unied Saes.24


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Economiss Francisco Buera and I boh provided an alernaive ramework o

undersand he resuls in Hurs and Lusardi’s sudy.25 By including enrepreneur-

ial abiliy in his analysis, Buera showed ha he relaionship beween wealh and

he probabiliy o becoming an enrepreneura he individual levelis hump

shaped. In oher words, his implies ha or a group o individuals wih he same

educaion, age, and experience, he chances o becoming an enrepreneur increase wih he availabiliy o capial o sar a business up o a poin, afer which enre-

preneurial abiliy among hose wih high ne worh diminishes.

In a relaed sudy, I showed ha he so-called aggregae ransiion probabiliy profile

relaive o wealhwhich indicaes he average racion o workers becoming enre-

preneurs a each level o ne worhdocumened in Hurs and Lusardi’s sudy is

no represenaive a he individual level. Te profile insead ends o be an invered

U shape, as in Buera’s aricle, or groups wih similar observable human-capial

characerisics such as educaion and age. Tis finding implies ha mos poenial

enrepreneurs in he economyand especially hose below he op o he wealhdisribuionace capial consrains when making he decision o sar a business.26

Tese sudies reaffirm he early consensus ha he availabiliy o financial capial or

individuals plays a criical role in osering he creaion o new firms in he economy.

In sum, individuals decide beween salaried work and opening heir own business

by comparing he benefis, coss, and risks o each alernaive. Tereore, when

making he decision o sar a business, each person akes ino accoun heir own

abiliies, knowledge, experience, as well as he level o uncerainy and heir willing-

ness o ake risk, in addiion o he availabiliy o financial resources o und he

invesmens and coss required o se up he new venure. In his regard, i is worh

noing ha even in highly developed financial sysemssuch as he Unied Saes’

sysemhe financial marke ofen excludes people rom borrowing and increases

he financing coss based on people’s wealh and oher demographic characerisics.

Te evidence presened in his secion includes a combinaion o some o hese ele-

mensobservable human capial, income, and accumulaed wealho explain

he main drivers o and barriers o he creaion o new firms in he economy. Te

acs presened in he remainder o his repor will explore business creaion rends

in he Unied Saes, in relaion o he evoluion o some o hese elemens. Teanalysis will use my heoreical ramework (described in Appendix A) as a reer-

ence, which includes observable characerisicswealh, educaion, and ageand

unobservable characerisics such as enrepreneurial abiliy and risk aversion.27


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How business ownership

in the United States has

evolved since the late 1960s

Te Panel Sudy o Income Dynamics, or PSID, is he larges longiudinal

survey o a represenaive sample o U.S. individuals and amilies. I began

collecing inormaion annually rom 1968 o 1997 and has colleced inormaion

biannually since hen. Te survey is conduced by he Insiue o Social Research

o he Universiy o Michigan and sponsored by several governmen agencies and

oher organizaions.

Academics rom many differen disciplines use he PSID or research, givenhe wide range o opics covered in he quesionnaire: housing, healh, income,

employmen, wealh, and savings, among ohers. Te survey collecs daa on he

household and on individual amily members. Business ownership and wealh are

measured a he household level, while occupaion is deermined a he individual

level. Tus, here are alernaive ways o define who is considered an enrepreneur

when using his daa. Te survey is a useul indicaor o he evoluion o enrepre-

neurship in he Unied Saes over he pas ew decades, as each survey wave since

is incepion conains daa on he number o U.S. business-owner households

defined as hose who declare ha someone in he amily owns a leas one business.

Figure 1 below deails hese daa.28 On average 9 percen o households were

business owners in he 1970s, and he number peaked a 13.6 percen a he end

o he lae 1990s do-com boom and bubble. Bu afer 2000, he share o amilies

engaging in enrepreneurial businesses ell seadily o 12.3 percen o households

by 2008 and alling urher o 11.8 percen by 2010 in he afermah o he Grea

Recession. aking he PSID daa analyzed here as a benchmark or he overall popu-

laion implies ha he U.S. economy produced 1 million ewer business-owner

households in he 2000s relaive o he 1990s.29

Te puzzling finding ha economic growh in he 2000s was accompanied by a

reducion in business creaion by American amilies provides he main moivaion

or his repor, which offers an alernaive explanaion o his phenomenon based

on he observed deerioraion o he financial healh or middle-class households

and heir diminished wealh accumulaion capaciy o finance enrepreneurial

endeavors over ime.


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Appendix B describes he differences in he rae o business ownership when

using he PSID and he Survey o Consumer Finances, or SCF, run by he Federal

Reserve. In shor, he SCF daa show ha he rae o business ownership in he

Unied Saes salled in he 2000s, ollowing an increasing rend in he 1990s.

o unveil he dynamics behind he number o enrepreneurs in he Unied Saes,

one can use he PSID daa o look a flows ino and ou o business ownership.

Figure 2 shows he five-year average racion o new business-owner households

each year, as a percen o he oal number o households ha did no own a busi-

ness in he previous PSID survey year.30 Tis measure o business creaion showed

seady increases rom 2.9 percen in he early 1970s o a peak o 4.7 percen rom

1996 o 2000. New business creaion never recovered o he 1990s economy peak

and hen ell urher o 4.1 percen in 2010.

No only have he 2000s been associaed wih slower growh in business owner-

ship in he Unied Saes, bu he decade also saw higher raes o enrepreneurs

giving up heir business in avor o oher wage-work employmen. Figure 3 shows

he average percenage o households ha no longer own a business as a percen-age o households ha previously repored owning a business. Te daa show ha

he percenage o business-owner households closing or selling heir businesses

each year ell and hen rose seadily afer 1980. Afer exiing sagflaion in he

1970s ino he win recessions spanning 1980 o 1982, business exi raes or U.S.

FIGURE 1

Average percentage of business-owner households

in the United States, 1971–2010

Source: Author’s analysis of Panel Study of Income Dynamics data.

15%

12%

9%

6%

3%

0%

1971–

1975

1976–

1980

1981–

1985

1986–

1990

1991–

1995

1996–

2000

2002–

2004

2006–

2008

9.1% 9.5%

13.4% 13.5% 13.6%

12.5% 12.3%

11.5% 11.8%

2010


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households rose rom 23 percen in 1980 o an average o 30 percen over he firs

decade o he 2000s. In sum, he upward rend in business ownership during he

1990sobserved in boh he Panel Sudy o Income Dynamics and he Survey

o Consumer Financesis he resul o increasing raes o business creaion and

sable raes o business closures, while he drop in he business-ownership rae

or he 2000s in he PSID is he resul o increasing closures and sagnan raes o business creaion.

FIGURE 2

Average percentage of new business-owner

households in the United States, 1971–2010


5%

4%

3%

2%

1%

0%

1971–

1975

1976–

1980

1981–

1985

1986–

1990

1991–

1995

1996–

2000

2002–

2004

2006–

2008

2.9%3.2%

3.8%4.0% 4.1%

4.7%

4.4% 4.6%

4.1%

2010

FIGURE 3

Average percentage of entrepreneur households

exiting from business, 1971–2010


35%

30%

25%

20%

15%

10%

5%

0%

1971–

1975

1976–

1980

1981–

1985

1986–

1990

1991–

1995

1996–

2000

2002–

2004

2006–

2008

30.0%

26.0% 27.3%

23.0% 23.3%

25.1%

29.1%

32.5%

28.6%

2010


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Income percentiles

0–20 21–40 41–60 61–80 81–100Top

10 percent

Top

5 percent41st–

1971–1979 6.8 13.3 18.2 25.2 36.6 20.0 12.3 59

1980–1989 9.1 14.1 20.6 24.3 31.9 16.8 9.0 60

1990–1999 9.5 15.0 19.6 26.2 29.7 16.1 8.3 59

2000–2010 9.2 13.8 19.8 24.3 32.8 16.6 8.1 60

TABLE 1

Fraction of new business owners by income distribution quintile


Under he assumpion ha preerences oward risk-aking and willingness o sar

businesses among he American populaion have no changed significanly, such a

patern o slowing growh o enrans and acceleraing raes o exis rom enrepre-

neurship suggess ha some oher srucural changes in he economy have se he

bar higher or who can become an enrepreneur in he Unied Saes.

able 1 below shows he percenage o new business owners by differen groups

along he income disribuion. Te majoriy o new business owners are, unsur-

prisingly, concenraed wihin he middle and upper ranges o he income disri-

buion, hough he wo quiniles o amilies wih incomes below $41,000 exhibi

noable levels, alhough lower, o enrepreneurship. Wha’s more, hese aciviies

end o be sel-employmen in rades or oher small enerprises wih very limied

survival, growh, and job creaion poenial, given he significan financial consrains

o which hese amilies are subjec.31

Families comprising a broad middle classrom he 40h percenile o he 90hpercenile o he disribuionor hose wih incomes beween $41,000 and

$151,000, according o he PSID daacomprise on average 60 percen o oal

new enrepreneurship in he Unied Saes.32 Middle class businesses run he

gamu rom mom-and-pop shops o large-growh-poenial sarups, across all

secors o he economy. Families a he op 5 percen o incomes also accoun or a

disproporionaely large share o new enrepreneurs, bu his group’s conribuion

o enrepreneurship ell markedly o 8 percen in he 2000s rom 12 percen in he

1970s; enrepreneurship by hose in he op 10 percen ell rom 20 percen o 17

percen in he same ime period.


16/38


Furhermore, Figure 4 compares he differen business-creaion raes in each o

hese income groups: ha is, low-income amilies up o he 40h income percen-

ile, middle-class amilies beween he 41s income percenile and 90h income

percenile, and high-income amilies a he op 10 percen o he income disribu-

ion. Firs, noe ha he sagnaion o business creaion in he 2000s documened

in Figure 2 is mainly due o he dynamics or amilies below he 90h incomepercenilelow-income and middle-class amilies. W hile business creaion

growh among low-income amilies sagnaed afer he 1990s, business creaion

raes increased seadily unil 2000 or middle-class amilies and decreased since

hen relaive o he level observed in he lae 1990s. On he oher hand, he rae o

business creaion among he op-income amilies coninued growing in he 2000s.

Tereore, no only do middle-class amilies accoun or 60 percen o business

creaion in he Unied Saes, bu hey also explain he sagnaion o business-

ownership growh raes in he 2000s compared o he lae 1990s. In conras, he

pace o business creaion among op-income amilies coninued unabaed unilhe Grea Recession.

FIGURE 4

Average percentage of new business-owner households

by income groups in the United States, 1971–2010Low income families (p0–p40

Middle income families (p41–

High income families (above


1971–1975 1976–1980 1981–1985 1986–1990 1991–1995 1996–2000 2002–2004 2006–2008 20100

2

4

6

8

10

12


17/38


The financial health of the

middle class and inequality

in the United States

Since he lae 1960s, in general, he income or amilies higher up he income

disribuionrelaive o income or hose amilies oward he botomhas

seadily rended upward. Boh PSID and Census daa show ha income disper-

sion has coninuously and gradually increased in he pas our decades. Families

a he 90h percenile o he income disribuion earned eigh o nine imes more

han amilies a he 10h percenile in he 1970s; since 2005, amilies a he 90h

percenile have earned more han 11 imes ha o hose a he 10h percenile.33

(see Figure 5)

Tere is a sark conras, however, beween levels o dispersion o income and

wealh. Analysis o PSID daa in Figure 6 shows he ne worh or amilies a he

90h percenile o he wealh disribuion was abou 50 imes ha o amilies a

he 25h percenile rom he mid-1980s o he mid-1990s. Tis raio increased

o 70-o-1 by he end o he 1990s and up o almos 97-o-1 in 2005. Te growh

hen became exponenial, ripling o 301-o-1 by 2009, and coninued growing

oward 317-o-1 in 2011.34

Tis exraordinary growh in wealh dispersion can be parly explained by he

housing bubble burs beginning in 2005 and ensuing financial crisis and recession

hrough he summer o 2009. Housing demand and prices in he Unied Saes

grew seadily since he early 2000s unil 2008, ueled by hisorically low ineres

raes and unprecedened growh in he marke or morgage-backed securiies

hanks o lack o proper regulaion. Ample and easy morgage credi increased

he risk profile o homebuyers, while banks and raing agencies did no properly

recognize such risks on he relaed securiies. Once hese higher risks sared

o maerialize in he orm o loan deauls, he process unraveled. Credi roze,

deauls cascaded, and home prices plummeed due o he resuling oversupplyo homes.35 Te financial collapse had a heavier impac on middle-class amilies

around or below he median wealh level, which are amilies ha ypically hold a

majoriy o heir ne worh in heir homes. Wealhier amilies, on he oher hand,

end o have a much larger and more diversified porolio o asses.36


18/38


Increasing inequaliy does no necessarily mean ha hose a he middle or he bo-

om are doing very badly. I could be he case ha he middle class is doing very well,

bu inequaliy increases jus because he op 10 percen or 5 percen are doing much

beter han he res o he populaion. Tis has no been he case in he Unied Saesin he pas decade, however. In a growing economy, or example, he consump-

ion and wealh accumulaion o he middle class may increase despie increasing

inequaliy driven by he exreme success o a small group o individualsmos

likely enrepreneurs. Tereore, raher han ocusing on relaive measures o inequal-

iy o assess he financial healh o he middle class, i is more adequae o look a he

evoluion o income and wealhin real ermsover ime.

FIGURE 5

Income-level ratio of 90th percentile to 10th percentile

of the U.S. income distribution, 1967–2010

Source: U.S. Census Bureau; author’s analysis of Panel Study of Income Dynamics data.

9

12

13

11

10

8

7

Census

PSID

1967 1972 1977 1982 1987 1992 1997 2002 2007 2010

FIGURE 6

Wealth level ratio of 90th percentile to 25th percentile

of the U.S. income distribution, 1984–2011


0

50

100

150

200

250

300

1984 1989 1994 1999 2001 2003 2005 2007 2009

Years observed

2011

317.1301

75.470.9

50.356.9

134.1

96.984.9

45.6


19/38


Figure 7 shows he evoluion o real median amily income since he lae 1960s,

based on PSID and Census daa. Boh series show an upward long-erm rend up

o year 2000, wih real median income growing beween 3 percen and 22 percen

in he 1980s and 1990sbeween 8 percen and 10 percen rom he Census series

and beween 3 percen and 22 percen rom he PSID series. Afer reaching is high-

es level beween 1999 and 2000above $57,500 in he wo seriesreal median

income declined and sagnaed a he level observed in he lae 1990s, which was

beween $54,200 and $57,650 rom 1997 o 1999, according o Census daa.37

Wealh inequaliy has been rising since he early 1980s hrough he 1990s and

2000s; he riches 1 percen o households received 38 percen o he oal gain in

wealh rom 1983 o 2010, while he botom 80 percen saw virually no increase.38

FIGURE 7

Median real family income, 1967–2010


50

44

46

48

52

54

56

58

60

2 0 1 4 d

o l l a r s ,

i n t

h o u s a n d s

1967 1972 1977 1982 1987 1992 1997 2002 2007 2010

PSID

Census

0

50

100

150

200

FIGURE 8

Real family income by percentile, 1967–2010

p95

p90

p80

p60

p40

p20 2 0 1 4 d

o l l a r s ,

i n t

h o u s a n d s

1967 1972 1977 1982 1987 1992 1997 2002 2007 2010



20/38


Figure 8, on he oher hand, looks a he evoluion o real income, by income levels.

Te lack o real income growh in he 2000s documened or he median amily in

Figure 7 is also shared by amilies a he 20h income percenile up o middle-class

amilies a he 60h income percenileha is, amilies in he firs, second, and

hird income quiniles. When using year 1998 as he benchmarkhe final survey

o he 1990s or which he PSID capures income daareal income changedmarginally or middle-class amilies up o he hird quinile, while amilies beween

he 80h percenile and 95h percenile saw an increase o 6 percen o 7 percen

beween 1998 and 2008. Following he Grea Recession, real income in 2010

declined beween 9 percen and 13 percen or amilies below he 40h income

percenile and around 7 percen or amilies above he 40h income percenile.

I is clear rom Figure 8 ha he growh rend in real income since he early 1990s

is flater or middle-class amilies below he 80h income percenile and seeper or

hose wih higher incomes. Tus, he abiliy o save and accumulae wealh in he

pas decade was significanly consrained or he ormer group, which, accordingo able 1, originaes almos hal o all business creaion in he U.S. economy.

Figure 9 shows he evoluion o median amily wealh and he role o home pricesin he oal ne worh o middle-class households. oal median wealh increased

rom $67,000 o abou $77,000 rom he second hal o he 1980s o he 1990s (in

2014 dollars). I coninued increasing seadily up o $99,000 in 2007 and hen by

2011, dropped dramaicallywih he 2009 crisissignificanly below he levels

observed back in he 1980s.

Source: Author’s analysis of Panel Study of Income Dynamics data.Note: No data available for intervening years.

FIGURE 9

Median real family wealth, 1984–2011

0

20

40

60

80

100

R e a l 2 0 1 4 d

o l l a r s ,

i n

t h o u s a n d s

200920072005200320011999199419891984 2011

Median family wealth

Median family wealthex-home equity


21/38


Te second (lower) se o bars in Figure 9 shows median ne worh rom sources

oher han home equiy. Te rend o hese alernaive sources o wealh is quie

differen han ha o he oal, as i shows an increasing patern rom he mid-

1980s o he mid-1990s, ollowed by a decrease in 1999mos likely relaed o

he Inerne bubbleand a coninued decreasing rend during he 2000s. Aside

rom poenial collaeralized loanswhich are guaraneed by an asse he bor-rower already owns, such as real esaehese alernaive sources o wealh usu-

ally become he seed capial or poenial enrepreneur households.

Wih regard o oher wealh groups, wealh declined by more han 30 percen

beween 1999 and 2009 or middle-class amilies a he 40h wealh percenile,

whereas median amily wealh declined by 6 percen over he same ime period.

Families beween he 80h percenile and 90h percenile o wealh, meanwhile,

saw increases in real wealh o 24 percen o 30 percen, respecively, during he

10-year period.

Figure 7 shows ha he period beween he mid-1980s and he mid-1990s was

characerized by rising median incomeconinuing an upward rend since he

1970swhich led o wealh accumulaion or all middle-class amilies. Bu ol-

lowing he Inerne bubble o he lae 1990s and he recession o he early 2000s,

income and wealh dispersion increased o hisorically high levels. More impor-

anly, he rends or he las decade show sagnan middle-class incomes a a ime

o rising home pricesconsiuing he main driver o wealh growh or mos

amilies hrough o 2007. Wealh los by amilies in he housing bubble burs, he

financial crisis, and he Grea Recession plunged he median amily’s wealh below

1980s levelsabou $68,000 in 2014 dollarsby year 2011 ollowing he housing

bubble burs. Tis sagnan median income and ephemeral paper gains in house-

hold ne worh were accompanied by a coninued decrease in he accumulaion o

non-real-esae sources o wealh.

In oher words, fla income or he majoriy o amilies deerred he American

middle class rom accumulaing much in he orm o non-real-esae wealh during

he 2000s. Tis ulimaely ranslaed ino lower possibiliies o save and accumu-

lae financial capial in order o overcome poenial liquidiy and credi consrains

or many o hose willing o sar new businesses.


22/38


Entrepreneurship trends

in the United States

As menioned beore, one’s occupaional choice is a leas parly condiional on

individual characerisics such as wealh and human capial. Given he broad

scope ha he later concep enails, his secion ocuses on observable dimen-

sions o human capialmainly educaion and ageamong U.S. households.39

Tese are capured hrough he household head’s repored level o educaion and

years o age, which is a proxy or years o working experience.

Le’s sar by looking a age. Figure 10 shows he mean and median age o he headso business-owner households per year since he 1970s. Te mean and median

age remained beween 40 and 45 years o age during he 1970s and 1980s, wih a

decline or mos o he 1970s and hen an increase in he second hal o he 1980s.

Tis increasing rend coninued hroughou he 1990s and 2000s or boh mean and

median age and has seemingly acceleraed is pace since he mid-1990s. Since 2008,

he mean and median age o he heads o business-owner households reached 50.

Hence, he average business owner has coninuously aged since he early 1980s, wih

average age annually increasing by 0.28 years over he pas 30 years.40

FIGURE 10

Mean and median age of the heads of business-owner

households, 1970–2010


Median

Mean

40

50

1970

52

48

46

44

42

1973 1976 1979 1982 1985 1988 1991 1994 1998 2004 2010


23/38


Tese daa imply ha eiher new enrepreneurs are delaying heir decisions o

sar businesses, or ha he number o new young enrepreneurs is no large

enough o offse he aging profile o he business owner populaion, or boh.

While he rend o business ownership documened in Figure 1 suppors he sec-

ond argumen, Figure 11 looks a he firs alernaive by showing he mean and

median age o he heads o new business-owner households in he PSID survey.

From he 1970s o he early 1980s, he average age o a new enrepreneur

hovered around 41 years old, bu afer he 1980s--as inequaliy across he U.S.

economy rose--so oo did he average age or a new business owner. By 2010,

he average age climbed o almos 48, an addiional 7 years. Similar upward

rends shown in boh he average and median age shows ha he phenomenon o

people waiing unil laer in lie o sar businesses is rising over he pas 30 years.

Tis phenomenon is consisen wih he heoreical ramework described in

Appendix A and he acs regarding business creaion and wealh accumulaion

capaciy or middle-class amilies in Figures 2 and 9. Under he heory described

in Appendix A, here exiss a minimum level o capial or each individual o sar

a business, deermined by is own characerisics. Tus, i a broad percenage ohe populaion has a lower capaciy o wealh accumulaion, as suggesed by he

analysis o Figures 8 and 9, amilies will require more ime o save beore making

he decision o sar a business.

FIGURE 11

Mean and median age of heads of new business-owner

households, 1970–2010


40

48

38

36

34

46

44

42

Median

Mean

1970 1973 1976 1979 1982 1985 1988 1991 1994 1998 2004 2010


24/38


Educaion, along wih years o working experience, is he oher main observable

driver o human capial. Figure 12 shows he racion o heads o new business-

owner amilies wih eiher some or compleed college educaion.41 On average,

abou hal o new enrepreneurs had up o high school educaion in he 1970s, o

which 40 percen did no complee high school.

During he 1980s and 1990s, he composiion o new business owners iled

oward higher educaion, wih around 60 percen o incoming enrepreneurs hav-

ing a leas some college educaion. While almos hree-quarers o he increased

share or his group was driven by college graduaes, abou wo-hirds o he

decreased share or new business-owner household heads wih up o a high school

educaion came rom hose a he lowes levelha is, hose who did no com-

plee high school. During he 2000s, he average share o new enrepreneurs wih

a leas some college educaion increased urherclose o 67 percenwih

mos o he increase coming again rom college graduaes. Tese daa show ha

he creaion o new businesses in he Unied Saes has been increasingly concen-raing among hose wih higher educaional atainmen in he pas our decades.

Moreover, his concenraion increased urher rom 2000 o 2010.

Alhough he heoreical ramework in Appendix A does no provide any par-

icular predicion abou he educaional composiion o curren or new business

owners, he evidence in Figure 12 may be relaed o he acs presened in Figures

2 and 8. Tose wih high educaional atainmen end o be locaed a he high-

es income perceniles, which among middle-class amilies end o be he ones

less affeced by consrains o capial accumulaion. Along hese lines, he recen

changes in he composiion o business owners oward higher educaional atain-

men could be generaed by larger capial accumulaion consrains or hose wih

low educaion levels. Tereore, sagnan incomes or households closer o he

middle o he income disribuion would imply a higher concenraion o business

ownership among hose wih higher educaion levels.

Having explored he changes in he composiion o new enrepreneurs wih

regard o human capial, he remainder o he analysis ocuses on he relaive level

o income and wealh or incoming business owners. Te main issues are how

income and wealh levels o incoming enrepreneurs compare o hose o heirpeer workers and how his relaionship has changed over ime.


25/38


o answer hese quesions, Figure 13 shows he raio o median real incomes or

non-business-owner households ha became enrepreneursby he nex survey

waveo non-business-owner households ha remained as workers.42 Te raio

flucuaed around an average level o 1.5-o-1 in he pas 40 years. I decreased

slighly o an average o 1.48-o-1 in he 1980s and 1990s rom 1.52-o-1 in he

1970s bu increased oward 1.6-o-1 in he pre-crisis years o he 2000s. Figure 13

suggess a U-shaped rend over ime. In oher words, he income level o poenial

enrepreneur amilies increased in relaion o ha o heir peer workers in he pas

decade, beore he Grea Recession.

Figure 14 replicaes he previous analysis or wealh. Te U-shaped patern over

ime is similar o he one in Figure 13. While he raio flucuaed around 1.9-o-1

rom he mid-1980s hrough he mid-1990s, i increased o 2.06-o-1 in 2006,

2.76-o-1 in 2008, and dropped o 1.96-o-1 in 2010. In oher words, he ne

worh o he median incoming enrepreneur used o be almos wo imes ha o

he median worker in he year beore saring his or her business during he sec-

ond hal o he 1980s and hroughou he 1990s. Furhermore, amilies ha were

new business owners in 2009given hey did no own a business during he pre-

vious PSID survey in 2007had almos hree imes more wealh han he medianamily no saring a business, when boh groups were sill no business owners.

FIGURE 12

Fraction of heads of new business-owner households

with some or completed college education, 1971–2010


40%

50%

60%

70%

80%

74.7%

67.5%66.6%

58.4%

60.6%

63.7%

60.1%

49.4%

52.5%

1971–

1975

1976–

1980

1981–

1985

1986–

1990

1991–

1995

1996–

2000

2002–

2004

2006–

2008

2010


26/38


1.5

FIGURE 13

Median real family income of new business-owner

households before becoming entrepreneurs relative

to non-business-owner households, 1969–2010

Source: Author’s analysis of Panel Study of Income Dynamics data. The solid line indicates a one-year period between the observations

to determine households’ business-ownership status change. Beginning in 1997, this period is two years, given the changes in the PSIDdata collection schedule.

1.6

1.7

1.8

1.4

1.3

1.2

1.1

1970 1974 1978 1978 1982 1986 1990 1994 1998 2002 2010

FIGURE 14

Median real family wealth of new business-owner

households before becoming entrepreneurs relative

to non-business-owner households, 1984–2010

Source: Author’s analysis of Panel Study of Income Dynamics data. The PSID started collecting wealth information every fiveyears in 1984. Beginning in 1999, the wealth information started to be collected every two years.

1.0

1.5

2.0

2.5

3.0

1984 1989 1994 2000 2002 2004 2006 2008 2010

Tese comparaive analyses o income and wealh raios or incoming business-

owner households and non-business-owner householdsbeore he ormer

became enrepreneurs, a a ime where boh groups did no own a businessare

addiional evidence supporing he idea ha middle-class amilies have been sub-

jec o increasing wealh accumulaion consrains. Tis is especially rue or hoseclose o he median o he income disribuion, and i has made enrepreneurship

a viable opion only or hose wih higher income and wealh levels.


27/38


Conclusion

Tis repor explores he dynamics o business ownership and firm creaion in

he Unied Saes in he pas our decades, paricularly ocusing on wha he

characerisics o incoming enrepreneurs reveal abou he sarup process over

ha ime period.

Te firs and main finding o his repor is ha business ownership declined

during he pre-crisis years o 2002 o 2008a period o low ineres raes, high

economic growh, and exraordinary availabiliy o credi or American amilieso 12.4 percen, compared o 13.6 percen in he 1990s. Tis is equivalen o a loss

o abou 1 million businesses, on average, in he 2000s relaive o he 1990s. Te

daa show ha he decline in business ownership resuled rom salling business

creaion raeshe percenage o households wihin he PSID becoming business

owners wihin one daa collecion period, eiher one year rom 1968 o 1997 or

wo years sinceand increasing raes o business closings.

Te remainder o his repor ocused, hereore, on he poenial acors behind

he lack o coninued growh in business creaion during he expansionary pre-

crisis years o he pas decade. Te acors explored are based on a heoreical

ramework used in recen sudies o enrepreneurship and occupaional choice.

According o his heory, he decision o become a business owner is influenced

by various idiosyncraic characerisics, in addiion o he availabiliy o enough

financial capial o sar he new business. Tese acors include observable charac-

erisics such as educaion and age, as well as unobservable ones such as enrepre-

neurial abiliy and risk olerance.

On he one hand, one’s level o educaion and ageas an approximaion o work

experiencecan open access o cerain indusries and occupaions, which uli-maely provide a differen se o business opporuniies, marke experience, and

indusry neworks. On he oher hand, educaion and age are also criical drivers

o labor income, which becomes he benchmark ha poenial enrepreneurs use

o balance he coss and benefis o choosing beween occupaionswhich are


28/38


parly deermined by enrepreneurial abiliy and risk. Furhermore, educaion

and age are imporan deerminans o oal income, which is he main vehicle o

accumulae he financial capial required o evenually open a new business.

Te daa also suppor he ac ha he middle classdefined in his repor as

amilies beween he 40h percenile and 90h percenile o he income disribu-ionhas been he main driver o business creaion in he Unied Saes, accoun-

ing or 60 percen o new business ownership since he 1970s. As such, business

creaion in he Unied Saes is closely relaed o he financial healh, dynamics,

and characerisics o he middle class.

Consisen wih oher sudies, he acs in his repor show ha real income or he

majoriy o middle-class amilieshose closer o he median and more gener-

ally hose below he 80h percenile o he income disribuionsagnaed in he

2000s, while real income or amilies in he op 10 percen o he income disri-

buion saw subsanial growh in he same period. Moreover, while oal wealhor middle-class amilies grew in he 2000s, i was mainly driven by he housing

bubble ha burs in 2009; non-real-esae wealh acually declined in he 2000s.

Recen sudies on occupaional choice reaffirm he consensus abou how wealh

and liquidiy consrains can be a key barrier o business creaion. In shor, i

hese consrains are binding, households will end o delay he decision o sar a

business. Te findings documened in his repor provide evidence in suppor o

his idea. Te resuls show ha he median and average age o new business-owner

household heads increased significanly since he lae 1990s.

Furhermore, he repor finds ha he median income and wealh o households

ha became business ownersjus beore saring heir businesswas much

higher han he median income and wealh o hose ha remained as workers

in he 2000s relaive o he 1980s and 1990s. In addiion, he daa in his repor

show a gradually increasing rend in he percenage o new business owners wih

more han a high school educaion. All o his reinorces he idea ha capial con-

srains or middle-class amilies are concenraing enrepreneurship among he

older, beter-educaed, and higher-earning households. In oher words, limied

wealh accumulaion capaciy has been gradually making enrepreneurship in America a luxury ype o good, mainly available o individuals wih high incomes

and a high ne worh.


29/38


In sum, he evidence documened in his repor suggess ha he deerioraion

in he financial healh o he middle class resrics hese amilies o more open

access o enrepreneurship. Tis has in urn resuled in a declining rae o business

ownership in America, which will negaively impac innovaion and growh in he

medium and long erm. Tus, srucural policies ocused on increasing access o

educaion and srenghening financial healhreal income and savings capac-iyo middle-class amilies will ulimaely help oser a vibran and dynamic

enrepreneurial economy in America.


30/38


Appendix A: Methodology

Te heoreical-numerical ramework used o inerpre and benchmark he

acs documened in his repor is ha o Mondragon-Velez. Tis is a parial

equilibrium model in which agens are heerogeneous in wealh, educaion,

age, and enrepreneurial abiliy. Each period, agens decide heir occupaion by

comparing uure expeced earnings in risky enrepreneurship, relaive o paid

work. Enrepreneurial earnings are a uncion o human capialeducaion and

agehe financial capial invesed in he firm, enrepreneurial abiliy, and unob-

servable risk; paid work earnings mainly depend on human capial. Poenialenrepreneurs can borrow unds agains heir wealh as collaeral. Te model is

esimaed so as o mach he long-erm averagerom 1968 o 1992earnings

profiles and racion o enrepreneurs by educaion and age or he Unied Saes.

Te esimaed model is a se o minimum capial requiremens o sar a busi-

ness by age, educaion, and enrepreneurial abiliy. Tese esimaed decision rules ,

along wih iniial disribuions o wealh and educaion, are used o generae

profiles o ransiion o enrepreneurship relaive o wealh or he U.S. economy.

In his seting, individuals wih some level o enrepreneurial abiliyspiri or

willingnesssar businesses i heir wealh holdings are a leas as large as he

minimum capial requiremen level or heir specific age and educaion. Tose

individuals who wan o sar firms bu do no have enough wealh o do so in a

paricular year will save more in he near uure o overcome heir wealh con-

srains. Tereore, his heory predics ha individuals will delay heir decision

o become business owners when wealh consrains are igher. Tis implies no

only ha poenial enrepreneurs sar heir businesses a an older age bu also ha

hey will need o accumulae higher levels o wealh han heir ypical peer worker

no ineresed in saring a firm.


31/38


Appendix B: Comparing the Panel

Study of Income Dynamics and the

Survey of Consumer Finances

When comparing he PSID business ownership raes wih hose available rom he

FED’s Survey o Consumer Finances, or SCF, levels and rends differ rom hose

presened in Figure 1.43 While he racion o enrepreneur households increased

seadily in he 1980s, according o he PSID survey, SCF daa show a sharp decline

beween 1981 and 1987 and a srong recovery by 1990 o a level above 13 percen,

similar o he one obained rom PSID daa. In addiion, he percenages o busi-

ness-owner households in he SCF remained below hose obained rom he PSID

survey or he 1990s, bu boh series show an upward rend or he decade. Finally,SCF enrepreneurship raes or he 2000s are o he same order o magniude as

hose rom he PSID; bu hey remained a he observed level in he lae 1990s

insead o declining. Overall, boh PSID and SCF daa show an increasing rend or

business ownership in he 1990s. While he PSID survey suggess a decline in he

racion o enrepreneur households or he 2000s, he SCF survey shows no growh

in he rae o business ownership, relaive o he dynamics o he prior decade.

6

9

12

15

FIGURE 15

Percentage of business-owner households in the United States,1968–2010, based on PSID and SCF data

Source: Author’s analysis of Panel Study of Income Dynamics and Survey of Consumer Finances data.

PSID

SCF

20102005200119981995199219891986198319801977197419711968


32/38


I is imporan o noe ha alhough boh surveys’ sample weighs are represen-

aive o he U.S. economy, he SCF survey oversamples households a he op

income brackes, while he PSID survey oversamples households a lower income

brackes. Tis could explain, a leas in par, differences in he resuling rae o

business ownership based on hese daases. Along hese lines, i could be argued

ha PSID figures are more represenaive o he vas majoriy o middle-classamilies in he economy.


33/38


About the author

Camilo Mondragón-Vélez is a senior research officer a he World Bank Group’s

Inernaional Finance Corporaion, or IFC, where he leads a eam under he IFC

chie economis uni–dedicaed o build a modeling and research ramework

o measure he economic and developmen impac o IFC operaions and linkhese o he World Bank Group win goals o eliminaing exreme povery and

boosing shared prosperiy. Previously, he led a eam ocused on global inves-

men porolio research and analysis, sress esing and asse allocaion. He holds

a Ph.D. and M.A. in economics rom Georgeown Universiy. Camilo received an

undergraduae degree in indusrial engineering wih honors in 1997 and a B.A. in

economics magna cum laude in 1998, boh rom he Universidad de los Andes in

Bogoá, Colombia. He augh inermediae macroeconomics in his naive counry,

Colombia, rom 1999 o 2001, as well as a Georgeown Universiy rom 2001

o 2006. He was a visiing proessor a he Universidad de los Andes in 2005 and

has been a member o he Naional Bureau o Economic Research, or NBER,Enrepreneurship Workgroup since 2006. Beore saring his graduae sudies, he

worked or he Colombian sae-owned oil company Ecoperol, coordinaing he

exploraion and producion invesmen porolio and implemening models or

policy design o he Colombian oil and gas indusry.

His research has been primarily ocused on enrepreneurship; paricularly on

he decision o become an enrepreneur and he financial reurns o enre-

preneurship. His Ph.D. disseraion, “Enrepreneurship, Human Capial and

Wealh,” was awarded he Razin Prize by Georgeown Universiy Economics

Deparmen in March 2007. Conribuions in hese areas have been published in

he Annals of Finance Special Issue on Entrepreneurship (2009) and he Kauffman

Symposium on Entrepreneurship and Innovation Data (2008). Te exension o his

research agenda or developing economies includes a conribuion on “Business

Ownership and Sel Employmen in Developing Economies” or he NBER’s

International Differences on Entrepreneurship volume; work on “Labor Marke

Rigidiies and Inormaliy in Colombia” published in Economia , he Journal of

the Latin American and the Caribbean Economic Association; and “Labor Marke

Rigidiies and Formal and Inormal Secor Wages in Colombia” in a volume by he

Colombian Cenral Bank. In his curren and previous posiions he also researchesinernaional finance, macroeconomics, indusry dynamics, developmen eco-

nomics, asse allocaion, and equiy markes, wih special emphasis on develop-

ing economies. In hese areas, his laes work includes sudies in business climae

reorm and equiy perormance, privae equiy and venure capial, and banks’

perormance along he business cycle.


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Athreya, Kartik, and Ahmet Akyol. 2007. “Unsecured Creditand Self-Employment.” St. Louis: S ociety for EconomicDynamics.

Åstebro, Thomas, and Irwin Bernhardt. 2003. “Start-upfinancing, owner characteristics, and survival.” Journal ofEconomics and Business 55 (4): 303–319.

— — —. 2004. “The winner’s curse of human capital.” Small

Business Economics 24 (1): 63–78.

Banerjee, Abhijit, and Andrew Newman. 1993. ”Occupa-tional Choice and the Process of Development.” Journal ofPolitical Economy 101 (1): 274–298.

Boháček, Radim. 2003. “Financial Constraints and Entrepre-neurial Investment.” Prague: CERGE-EI.

Boushey, Heather, and Adam Hersh. 2012. “The AmericanMiddle Class, Income Inequality, and the Strength of OurEconomy.” Washington: Center of American Progress.

Buera, Francisco J. 2009. “A Dynamic Model of Entrepreneur-ship with Borrowing Constraints: Theory and Evidence.” Annals of Finance 5 (3): 443–464.

Cagetti, Marco, and Mariacristina De Nardi. 2009. “EstateTaxation, Entrepreneurship and Wealth.” American Economic

Review 99 (1): 85–111.

Díaz-Giménez, Javier, Vicenzo Quadrini, and José V. Ríos-Rull. 1997. “Dimensions of Inequality: Facts on the U.S. Dis-tributions of Earnings, Income, and Wealth.” Federal ReserveBank of Minneapolis Quarterly Review 21 (2): 3–21.

Evans, David S., and Boyan Jovanovic. 1989. “An estimatedmodel of entrepreneurial choice under liquidity constraints.” Journal of Political Economy 97 (1): 808–827.

Evans, David S., and Linda S. Leighton. 1989. ”Some Empiri-cal Aspects of Entrepreneurship.” American Economic Review 79 (1): 519–535.

Frese, Michael. 2009. “Toward a Psychology of Entrepre-neurship—An Action Theory Perspective.” Foundations andTrends in Entrepreneurship 5 (6): 435–494.

Galor, Oded, and Joseph Zeira. 1993. ”Income Distributionand Macroeconomics.” Review of Economic Studies 60 (1):35–52.

Gentry, William M., and Glenn R. Hubbard. 2001. “Entre-preneurship and Household Saving.” New York: ColumbiaBusiness School.

Hamilton, Barton H. 2000. “Does entrepreneurship pay?An empirical analysis of the returns of self-employment.” Journal of Political Economy 108 (1): 604–631.

Haltiwanger, John, Ron S. Jarmin, and Javier Miranda. 2013.“Who Creates Jobs? Small vs. Large vs. Young.” Review ofEconomics and Statistics 95 (2).

Holt, Charles A., and Susan K. Laury. 2002. “Risk Aversion

and Incentive Effects.” The American Economic Review 92 (5):1644–1655.

Holt, Jeff . 2009. ”A Summary of the Primary Causes of theHousing Bubble and the Resulting Credit Crisis: A Non-Tech-nical Paper.” The Journal of Business Inquiry 8 (1): 120–129.

Hurst, Erik, and Annamaria Lusardi. 2004. “LiquidityConstraints, Wealth Accumulation and Entrepreneurship.” Journal of Political Economy , 112 (2): 319–347.

Kuznets, Simon. 1955. “Economic Growth and I ncomeInequality.” American Economic Review 65 (1): 1–28.

Lucas, Robert E. 1978. “On the Size Distribution of BusinessFirms.” The Bell Journal of Economics 9 (2): 508–523.

Markowitz, Harry. 1952. “Portfolio Selection.” The Journal ofFinance 7 (1): 77–91.

Meh, Cesaire A. 2003. ”Entrepreneurial Risk, CreditConstraints and the Corporate Income Tax: A QuantitativeExploration.” Working Paper 02-21. Bank of Canada.

— — —. 2005. “Entrepreneurship, Wealth Inequality andTaxation.” Review of Economic Dynamics 8 (3): 688–719.

Mondragón-Vélez, Camilo 2007. “Entrepreneurship, HumanCapital and Wealth.” Washington: Georgetown University.—— —. 2009. “The Probability of Transition to Entrepre-neurship Revisited: Wealth, Education and Age.” Annals ofFinance 5 (3): 421–441.

New America Foundation. 2012. “Out of Business: Measur-ing the Decline of American Entrepreneurship.” Washington.

Quadrini, Vincenzo. 1999. “The Importance of Entrepre-neurship for Wealth Concentration and Mobility.” Review of

Income and Wealth 45 (1): 1–19.— — —. 2000. “Entrepreneurship, saving and social mobil-ity.” Review of Economic Dynamics 3 (1): 1–40.

Terajima, Yaz. 2006. “Education and Self-Employment:Changes in Earnings and Wealth Inequality.” Working Paper06-40. Bank of Canada.

Acknowledgments

Te auhor would like o hank he Cener o American Progress or financial

suppor, Adam Hersh or useul suggesions and commens, and Guangyu Nie

or excellen research assisance. Te views expressed in his paper belong o he

auhor and do no necessarily represen hose o he IFC, IFC managemen, or he World Bank Group. All errors and omissions are he auhor’s own.

References


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1 The Panel Study of Income Dynamics, or PSID, is anational panel representative survey—the longesthousehold longitudinal household survey in theworld—managed by the Institute for Social Research,or ISR, at the University of Michigan. For more informa-tion, see PSID, “The Panel Study of Income Dynamics– PSID – is the longest running longitudinal householdsurvey in the world,” available at http://psidonline.isr.

umich.edu/ (last accessed December 2014).

2 This definition is somehow consistent with the classstructure suggested by William Thompson and JosephHickey in 2005, which categorizes household withincomes between $35,000 and $75,000 as “lowermiddle class” and households with incomes above$100,000 as “upper middle class” while defining “upperclass” as those with incomes above $500,000. The worksof Dennis Gilbert in 2002 and Leonard Beeghley in2004 include related class structure classifications forthe United States. Dennis Gilbert, The American ClassStructure in an Age of Growing Inequality (Belmont,CA: Wadsworth Publishing, 2002); William Thompsonand Joseph Hickey, Society in Focus (Boston: Allyn andBacon, 2005); Leonard Beeghley, The Structure of SocialStratification in the United States (Boston: Allyn andBacon, 2004).

3 The Small Business Administration website cites thefollowing as sources for these facts: U.S. Deptartment ofCommerce, U.S. Census Bureau, and International TradeAdministration. U.S. Small Business Administration,“Frequently Asked Questions,” available at http://www.sba.gov/sites/default/files/FAQ_Sept_2012.pdf (lastaccessed October 2013); Kathryn Kobe, “the Small Busi-ness Share of GDP, 1998-2004” (Washington: EconomicConsulting Services, 2007), available at www.sba.gov/advo/research/rs299.pdf; CHI Research, “Small SerialInnovators: The Small Firm Contribution to TechnicalChange” (2003), available at www.sba.gov/advo/re-search/rs225.pdf; Bureau of Labor Statistics, Small SerialInnovators: The Small Firm Contribution to TechnicalChange (U.S. Department of Labor, 2003).

4 John Haltiwanger, Ron S. Jarmin, and Javier Miranda,“Who Creates Jobs? Small vs. Large vs. Young,” Review ofEconomics and Statistics, 95 (2) (2013).

5 Note that in order to have a growing private sector,business creation needs to offset business failure,which tends to be high given the significant risks inher-ent to startups and new ventures.

6 Author’s analysis of see PSID, “The Panel Study ofIncome Dynamics.”

7 A recent study by the New American Foundationtitled “Out of Business: Measuring the Decline ofAmerican Entrepreneurship” shows declining trendsfor new firms, existing firms, and establishment entryrates—when adjusted by the size of the working-agepopulation—since the late 1970s, using Census Bureaudata. Their results about the self-employment rate—amore individual measure of entrepreneurship—showsimilar trends as the ones found in this report withregard to business ownership: increasing in the 1980s

and 1990s and declining in the late 1990s and 2000s.The New America Foundation, “Markets, Enterprise,and Resiliency Initiative” (2012), available at http://newamerica.net/sites/newamerica.net/files/policydocs/Out%20of%20Business,%20July%202012_0.pdf .

8 The PSID collected data annually since inception andup to year 1997 and biannually since.

9 Samuel Bowles and Herbert Gintis, “The Inheritanceof Inequality,” Journal of Economic Perspectives16 (3)(2002): 3–30.

10 For a study on social mobility and entrepreneurship,see Vincenzo Quadrini, “The Importance of Entre-preneurship for Wealth Concentration and Mobility,”Review of Income and Wealth 45 (1) (2000).

11 It is important to note that the evidence presented inthis report is agnostic about direct policy interventionsto provide seed capital, services, or business educationto potential or start-up business owners and entrepre-neurs.

12 One way in which theoretical models of entrepreneur-ship include entrepreneurial ability is by including itas a driver of the output of the firm as a form of produc-tivity factor. The theoretical study by Professor RobertLucas in 1978 included the entrepreneur’s manage-ment talent, as well as span of control to define theentrepreneurial production function. The occupationalchoice model by Professor Francisco Buera shows thetheoretical implications of considering the distributionof ability across the population. In this model, individu-als with zero ability are reflecting in s ome sense thefraction of the population with no entrepreneurial

spirit. Through a calibrated partial equilibrium modelof occupational choice, which adds human capital—asa function of education and age—to the frameworkproposed by Professor Buera, Mondragón-Vélezestimates empirically the fraction of the populationwith no entrepreneurial spirit, as well as a simpli-fied distribution of entrepreneurial skills among theAmerican population. Strictly s peaking, entrepreneurialskill in this model should be seen as a combinationof entrepreneurial spirit and skill. Given that thesecharacteristics are not observable, they are estimated

jointly in this empirical study. Camilo Mondragon-Velez, “Entrepreneurship, Human Capital and Wealth”(Washington: Georgetown University, 2007); FranciscoJ. Buera, “A Dynamic Model of Entrepreneurship withBorrowing Constraints: Theory and Evidence,” Annalsof Finance 5 (3) (2009): 443–464; Nancy M. Carter andothers, “The career reasons of nascent entrepreneurs,”Journal of Business Venturing 18 (1) (2003): 13–39;

Other strands of research attempt to differentiatebetween entrepreneur-specific characteristics andmotivations in determining the choice to becomeand the eventual success or failure of a venture. SeeGavin Cassar, “Money, money, money? A longitudinalinvestigation of entrepreneur career reasons, growthpreferences and achieved growth,” Entrepreneurship &Regional Development (19) (1) (2007): 89–107; RobertA. Baron, and Gideon D. Markman, “Beyond socialcapital: the role of entrepreneurs’ social competence intheir financial success,” Journal of Business Venturing,(18) (1) (2003): 41–60.

13 See, for instance, Global University EntrepreneurialSpirit Students’ Survey, “GUESSS,” available at http://www.guesssurvey.org/ (last accessed July 2013); “Mon-ster.com,” available at http://www.monster.com/ (lastaccessed July 2013); Dan Schawbel, “Multi-GenerationalWorker Attitudes Study” (Boston: Millennial Branding,

2013). 14 For a comprehensive literature review and reference list

in this area, see Michael Frese, “Toward a Psychologyof Entrepreneurship—An Action Theory Perspective,”Foundations and Trends in Entrepreneurship 5 (6) (2009):435–494.

Endnotes

http://psidonline.isr.umich.edu/http://psidonline.isr.umich.edu/http://www.sba.gov/advo/research/rs225.pdfhttp://www.sba.gov/advo/research/rs225.pdfhttp://newamerica.net/sites/newamerica.net/files/policydocs/Out%20of%20Business,%20July%202012_0.pdfhttp://newamerica.net/sites/newamerica.net/files/policydocs/Out%20of%20Business,%20July%202012_0.pdfhttp://newamerica.net/sites/newamerica.net/files/policydocs/Out%20of%20Business,%20July%202012_0.pdfhttp://www.guesssurvey.org/http://www.guesssurvey.org/http://www.monster.com/http://www.monster.com/http://www.guesssurvey.org/http://www.guesssurvey.org/http://newamerica.net/sites/newamerica.net/files/policydocs/Out%20of%20Business,%20July%202012_0.pdfhttp://newamerica.net/sites/newamerica.net/files/policydocs/Out%20of%20Business,%20July%202012_0.pdfhttp://newamerica.net/sites/newamerica.net/files/policydocs/Out%20of%20Business,%20July%202012_0.pdfhttp://www.sba.gov/advo/research/rs225.pdfhttp://www.sba.gov/advo/research/rs225.pdfhttp://psidonline.isr.umich.edu/http://psidonline.isr.umich.edu/


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15 Harry Markowitz, “Portfolio Selection,” The Journal ofFinance (7) (1) (1952): 77–91.

16 Charles A. Holt and Susan K. Laury, “Risk Aversion andIncentive Effects,” The American Economic Review 92 (5)(2002): 1644–1655.

17 Heather Boushey and Adam Hersh, “The AmericanMiddle Class, Income Inequality, and the Strength ofOur Economy (Washington: Center for American Prog-ress, 2012), available at http://www.americanprogress.org/issues/economy/report/2012/05/17/11628/

the-american-middle-class-income-inequality-and-the-strength-of-our-economy/.

18 The dynamics between entrepreneurship and inequal-ity illustrate a two-way relationship: a strong middleclass and social safety nets facilitate the formation ofentrepreneurship; however, the success of entrepre-neurs may increase overall inequality if growth is notbroadly dispersed. Empirical evidence for the UnitedStates shows that entrepreneurs have higher earn-ings and wealth holdings than salaried workers. Thisgroup, therefore, explains important characteristics ofinequality in the economy. In fact, Quadrini, Gentry andHubbard, Boháček, and Cagetti and De Nardi show thecritical role entrepreneurs have in explaining the risinginequality in the “upper tail” of the wealth distribution.For other references with regard to entrepreneur-ship and education, see Quadrini, “The Importanceof Entrepreneurship for Wealth Concentration and

Mobility.”; William M. Gentry and Glenn R. Hubbars,“Entrepreneurship and Household Saving” (New York:Columbia University, 2001); Radim Boháček, “FinancialConstraints and Entrepreneurial I nvestment” (Prague:CERGE-EI, 2003); Marco Cagetti and Mariacristina DeNardi, “Estate Taxation, Entrepreneurship and Wealth,” American Economic Review 99 (1) (1989): 85–111; JavierDiaz-Gimenez, Vincenzo Quadrini, and José V. Ríos-Rull,“Dimensions of Inequality: Facts on the U.S. Distribu-tions of Earnings, Income, and Wealth,” Federal ReserveBank of Minneapolis Quarterly Review 21 (2) (1997):3–21; Yaz Terajima, “Education and Self-Employment:Changes in Earnings and Wealth Inequality.” WorkingPaper 06-40 (Bank of Canada, 2006).

19 Camilo Mondragón-Vélez, “The Probability of Transitionto Entrepreneurship Revisited: Wealth, Education andAge,” Annal of Finance 5 (3) (2009): 421–441; For oneof the first studies to discuss occupational choice and

initial conditions in terms of education, see Oded Galorand Joseph Zeira, “Income Distribution and Macroeco-nomics,” Review of Economic Study 60 (1) (1993): 35–52.

20 Yaz Terajima, “Education and S elf-Employment:Changes in Earning and Wealth I nequality.” WorkingPaper 06.40 (Bank of Canada: 2006); Mondragón-Vélez,“Entrepreneurship, Human Capital and Wealth.”

21 Mondragón-Vélez used SCF 1998 data to show that thefraction of entrepreneurs within the American workingpopulation increased up to ages between the mid andlate 1940s and declined thereafter. Mondragón-Vélez,“Entrepreneurship, Human Capital and Wealth.”

22 Barton H. Hamilton, “Does entrepreneurship pay? Anempirical analysis of the returns of self-employment,” Journal of Political Economy 108 (1) (2000): 604–631;Thomas Åstebro and Ir win Bernhardt, “The winner’s

curse of human capital,” Small Business Economics 24 (1)(2004): 63–78; Mondragón-Vélez, “Entrepreneurship,Human Capital and Wealth.”

23 David S. Evans and Linda S. Leighton, ”Some EmpiricalAspects of Entrepreneurship,” American Economic Re-view 79 (1) (1989): 519–535; David S. Evans and BoyanJovanovich, “An estimated model of entrepreneurialchoice under liquidity constraints,” Journal of PoliticalEconomy 97 (1) (1989): 808–827. Abhijit Banerjee andAndrew Newman also study the occupational choicedependence on wealth constraints. Abhijit Banerjeeand Andrew Newman, “Occupational Choice and theProcess of Development,” Journal of Political Economy 101 (1) (1993): 274–298.

24 Erik Hurst and Annamaria Lusardi, “Liquidity Con-straints, Wealth Accumulation and Entrepreneurship,” Journal of Political Economy 112 (2) (2004): 319–347.

25 Buera, “A Dynamic Model of Entrepreneurship with Bor-rowing Constraints: Theory and Evidence”; Mondragón-Vélez, “Entrepreneurship, Human Capital and Wealth”;Mondragón-Vélez, “The Probability of Transition toEntrepreneurship Revisited: Wealth, Education andAge.”

26 Mondragón-Vélez shows that the effects of entre-preneurial ability and the opportunity costs impliedby paid work offset those of wealth accumulation toovercome credit constrains for most potential entre-preneurs in the economy, which ultimately explainsthe flat profile obtained by Hurst and Lusardi at theaggregate level. In other words, Hurst and Lusardi’s flatprofile is not the result of the lack of capital and credit

constraints but is precisely generated by these bindingconstraints at t

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