Abstract
We empirically test if household wealth inequality affects borrowing constraints of young entrepreneurs. We construct a measure of wealth inequality at the US county level based on the distribution of financial rents in 2004. We find that in more unequal areas, entrepreneurs are less likely to apply for a loan fearing that their applications will be turned down and they use more of their own funds to finance their ventures. In more unequal areas, the number of bank establishments per capita is lower, this effect being stronger during the 2007–2008 financial crisis.
Highlights
Entrepreneurs are central in the process of economic growth
While the first part of our analysis shows that during the crisis, banks cut credit to every entrepreneur, and the second part suggests that banks were more likely to fail and divest in Evidence from the Kauffman Firm Survey areas with higher wealth inequality
From the Kauffman Firm Survey (KFS), we extract the financial information for an 8-year period from 2004 up to 2011 on individual US start-ups during their early years of operation
Summary
Entrepreneurs are central in the process of economic growth. Entrepreneurial activities spur capital formation, generate technological progress, and create employment. We find that, when we instrument the wealth inequality measure, in more unequal areas, entrepreneurs are less likely to apply for a loan as they fear to be turned down This effect is both statistically and economically significant, a standard deviation increase in local wealth inequality increases this probability by 73%. A standard deviation increase in wealth inequality increases the proportion of owners’ equity to total finance with 33%, evaluated at the mean of the dependent variable We find that these effects are concentrated in the pre-2008 period, after the financial crisis inequality does not have a statistically significant effect on entrepreneurs’ access to finance. We interpret these results as evidence that banks cut credit across the board without distinguishing amongst entrepreneurs located in different areas.
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