Agents are heterogeneous in their entrepreneurial talent

Agents are heterogeneous in their entrepreneurial talent and wealth. Based on this, they melanin inhibitor decide between three occupations: wage working, entrepreneurship in the formal sector and entrepreneurship in the informal sector. Differently from Evans and Jovanovic, we also allow wages to be endogenous, which gives rise to nontrivial effects on income distribution. We calibrate the model to approximate features of the Brazilian economy, and evaluate the effects of taxation and credit constraints on efficiency (aggregate output), formalization and inequality. Our work is related to a large literature that evaluates the effect of credit market frictions on entrepreneurship (see for instance Evans and Jovanovic, 1989; Blanchflower and Oswald, 1998; Paulson and Townsend, 2004; Buera, 2008). Our main contribution is to add two different sectors (formal and informal) to the classic model of Evans and Jovanovic. This allows us to analyze not only the effect of credit constraints, but also of taxation. Moreover, these effects can be larger than in a model with a single sector, since changes in parameters induce individuals to switch sectors that have different technologies. The focus on efficiency is motivated by the literature on misallocation (Hsieh and Klenow, 2007; Restuccia and Rogerson, 2008), especially Jeong and Townsend (2007) and Banerjee and Moll (2010), which analyze the effect of credit market frictions on aggregate productivity. Regarding the effect on inequality, our work is particularly related to Cagetti and De Nardi (2006). Once more, considering the informal sector can amplify the effect of such frictions, since they influence the sector (and therefore technology) in which individuals choose to operate. The present study is also related to papers that model the informal sector, such as Rauch (1991), Amaral and Quintin (2006), Antunes and Cavalcanti (2007), D’Erasmo and Moscoso-Boedo (2012), De Paula and Scheinkman (2011) and Ordonez (2014). The rest of the paper is organized as follows. Section 2 describes the model. Section 3 explains how the model was calibrated to the Brazilian economy. Section 4 presents simulations regarding changes in credit frictions and taxation, and analyzes the effects on efficiency, occupational choice and inequality. Section 5 concludes.
Model Our starting point is the model proposed by Evans and Jovanovic (1989). Specifically, there is a set of individuals, heterogeneous in their wealth and entrepreneurial talent. Each of them chooses either to be an entrepreneur or a wage worker. To become an entrepreneur, the individual may need to borrow resources. The presence of borrowing constraints then implies that occupational choice depends not only on entrepreneurial talent, but also on wealth. We add to Evans and Jovanovic (1989) by introducing two different sectors in which the entrepreneur can operate: the formal sector and the informal sector. In the former, the entrepreneur may borrow a limited amount of resources to finance her business but has to pay taxes, whereas in the informal sector the individual can evade the payment of taxes, but has to rely exclusively on her wealth (she has no access to credit markets). We consider a small open economy, so that the interest rate is exogenously fixed. Nonetheless, differently from Evans and Jovanovic (1989), wages are set according to a market clearing condition.
Calibration
Simulations Fig. 1(a) plots agents according to their characteristics and occupational choices, in an environment with no taxes (τ=τ=0) and no credit constraints on formal entrepreneurs (λ=∞). In this case, all entrepreneurs operate in the formal sector. Moreover, occupational choice depends only on talent: if θ is sufficiently high, the individual becomes an entrepreneur; otherwise, she chooses to be a wage worker. Fig. 1(b) introduces the borrowing constraint on formal entrepreneurs. We keep tax rates at zero, so that Leaky mutations is still not optimal to operate in the informal sector. This is the case studied by Evans and Jovanovic (the only difference here is that wages are endogenous). Now occupational choice depends on wealth as well as talent. In particular, there are two margins of inefficiency entailed by the borrowing constraint: (i) the intensive margin, that is, individuals with high θ and low z become constrained entrepreneurs and have to operate at scales lower than optimal; and (ii) the extensive margin, that is, some of these high-talent individuals prefer to become wage workers. These effects also reduce the demand for labor and, therefore, equilibrium wages.