Entrepreneurial drain under moral hazard: A high-yield sector curse?

We describe a two-sector, general-equilibrium model of productive sorting under output risk and incomplete information. Risk-neutral (entrepreneurial) individuals can either produce alone, or - acting as employers/insurers - team up with risk-averse (non-entrepreneurial) individuals. Although the latter option has the potential to generate more surplus, when effort is unobservable and risk is high, the moral hazard problem in mixed matches may be too severe for mixing to be attractive to both risk-aversion types, leading to a segregated equilibrium in which risk-averse individuals select low-risk, low-yield activities. An increase in the profitability of the riskier sector can then trigger a switch from a mixed to a segregated equilibrium and cause aggregate output to fall. Evidence from a panel of non-OECD countries - showing that the presence of uninsured, small-scale mining firms has a negative impact on the relationship between natural resource exports and agrarian productivity - suggests that this 'high-yield sector curse' might be present in natural resource-rich, low-income countries. (C) 2009 Elsevier B.V. All rights reserved.