Credit Constraints and Delayed Entrepreneurship

How much do financial constraints delay entrepreneurship and how much do they cost households in terms of foregone welfare and implied inequality in countries with large informal sectors and poorly developed financial markets? I use a dynamic occupational choice model with credit constraints to empirically study the role of financial frictions in delaying micro-entrepreneurship in such countries. The main prediction of the model is that individuals with low entrepreneurial talent remain in subsistence work whereas those with higher entrepreneurial talent and low collateral have to delay their entry decision but may eventually become entrepreneurs if their initial wealth and future savings allow them to escape from poverty traps. The model is estimated and tested using both reduced-form survival analysis and structural maximum likelihood methods with data from Cameroon. Ifind that prospective entrepreneurs would need to work for an average of 7.1 years as subsisters to accumulate the minimum savings required to start their microenterprise. Among the potential entrepreneurs about 53% are subsisters implying a missing proportion of entrepreneurs of 10.9% of households among which more than32% have wealth below their estimated poverty traps. Counterfactual simulations of a credit access policy using the estimated model show that a high-talent median-wealth household’s permanent consumption would increase by 30% should credit constraints be removed completely. Relaxing the collateral constraint can eliminate delays to entry, double the fraction of entrepreneurs while reducing inequality by at least 6.4 percentage points in the Cameroon’s Gini index