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ABSTRACT: Do Household Savings Encourage Entrepreneurship? Household Wealth, Parental Wealth, and the Transition in and out of Entrepreneurship1

Erik Hurst, University of Chicago Graduate School of Business and NBER
Annamaria Lusardi, Dartmouth College and NBER

March 2006

I. Introduction
Entrepreneurs have traditionally played an important role in economic growth.2 They are central to many issues in both economic theory and public policy. Because of their importance, many countries have programs and institutions aimed to encourage entrepreneurship. For example, the United States established the Small Business Administration (SBA) in 1953 to monitor and promote business ownership. One of the focuses of the SBA has been entrepreneurs' access to capital. The SBA has provided nearly 20 million small businesses with direct or indirect help since 1953. During the 1990s alone, the SBA has helped close to 435,000 small businesses receive more than $94.6 billion in loans.3

Many leading empirical papers show that, despite the attempts of governmental agencies in general and the development of financial markets in particular, liquidity constraints are still an important deterrent to business ownership. Several papers referenced in this work find that wealth is positively correlated with the propensity to start a business. That is, the richer the household, the more likely it is to start a business. These papers all conclude that liquidity constraints prevent would-be entrepreneurs from starting their businesses.

In our work, we show that the evidence that liquidity constraints prevent households from entering entrepreneurship in the U.S. during the last two decades is, in fact, very weak. Although, like other authors, we find a positive correlation between initial household wealth and the probability that a household will subsequently start a business, this is no proof that liquidity constraints bind entrepreneurs in starting their businesses. Using additional empirical specifications, a much richer set of data, and exploration of the variations in economic conditions during the past two decades, we are able to examine the underlying reasons for the correlation between wealth and entrepreneurship in depth.

We use several data sources to perform our empirical analysis: the Panel Study of Income Dynamics (PSID), the Health and Retirement Study (HRS), the National Longitudinal Survey of youth (NLSY), and the National Survey of Small Business Finances (NSSBF), which cover different groups of the population for the late 1980s and the 1990s. Using these different sources of information, we first document some important facts about business owners. We then demonstrate that the relationship between wealth and business ownership does not necessarily imply the existence of binding liquidity constraints. The data sets give us a better understanding of who the entrepreneurs are and provide evidence that the correlation between wealth and business entry is, at least in part, due to differences between business owners and non-business owners in abilities, preferences, and family backgrounds.

Contrary to the predictions of a model of entrepreneurship with liquidity constraints, we show that the relationship between wealth and business entry is highly non-linear. Over most of the distribution of wealth, there is no discernible difference in the propensity to become a business owner. It is only at the very top of the wealth distribution (top 5 percent) that a positive relationship between wealth and business entry can be found. Moreover, liquidity constraints should be more stringent for firms requiring high initial capital. However, segmenting businesses into industries with high and low starting capital requirements, we find no evidence that wealth matters more for businesses requiring higher initial capital.

A few researchers have provided a different test for liquidity constraints. Rather than using wealth, they use inheritances as a proxy for liquidity. They show that those who receive inheritances are subsequently more likely to start businesses, again arguing that liquidity constraints limit business ownership. This certainly represents a superior method to test for liquidity constraints. However, inheritances are not randomly distributed in the population. In fact, they are more likely to be received by those at the top of the wealth distribution, thus capturing the non-linear relationship between wealth and business entry we had uncovered in our work. Moreover, inheritances may simply proxy for talents and ability; those with talented and rich parents inherently display a higher propensity toward business ownership. To prove this claim, we show that, not only past inheritances, but also future inheritances (inheritances received after the business is started) are correlated with business entry. Another fact supporting our argument is that the recipients of inheritances already have large amounts of wealth, often much more than is needed to start a business.

We propose a new measure of liquidity: capital gains on housing. House prices have increased over time and across regions in the US, often delivering large capital gains to homeowners. The increase in wealth deriving from capital gains is spread throughout the wealth distribution and does not affect simply those at the top of the wealth distribution. Moreover, households can easily access this increase in wealth by borrowing against home equity. When using this alternative measure of liquidity, we do not find any evidence that those households who benefit from an increase in their home equity are more likely to start a business.

The paper is organized as follows: In section II, we describe our data and report some simple facts about entrepreneurship and wealth. In section III, we examine the relationship between wealth and the transition into business ownership. We also explore the role and importance of parental wealth. In section IV, we investigate the positive correlation between inheritances and business entry. In section V, we propose a different measure of liquidity: capital gains on housing. In section VI, we investigate the relationship between liquidity constraints and survival into entrepreneurship and, in the final section, we summarize our main findings and conclude.

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1 This paper was written to be presented at a conference organized by the Hudson Institute in Washington, DC, on "Do Household Savings Encourage Entrepreneurship"? The paper draws heavily on our work published in the April 2004 issue of the Journal of Political Economy. We thank our discussant, Petra Todd, and participants to the conference for many suggestions and comments. Financial support from the Polsky Center for Entrepreneurship at the University of Chicago Graduate School of Business via a grant from the Kauffman Foundation is gratefully acknowledged. Yuni Yan provided excellent research assistant. Any errors are our responsibility.

2 As discussed later, there is no clear-cut definition of entrepreneurs. In this paper, we use the word entrepreneurs and business owners interchangeably.

3 See SBA's overview and history at http://www.sba.gov/aboutsba/history.html

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