Fewer, Bigger Entrepreneurs Explains Rising Inequality

Why has wealth inequality increased in the United States? A lot of semi-plausible but vague theories have been offered–changes in the tax code, the diminished role of unions and so forth–but there are surprisingly few fully-specified models. In an important paper, Mohsen Mohaghegh (on the job market) has a new answer.

Wealth inequality has risen considerably in the US since 1975. For instance, the wealth share of households in the top 1 percent of the distribution rose from 25 percent in 1975 to more than 37 percent in 2007. This paper builds on theories of entrepreneurship and wealth inequality to address changes in inequality in the US between 1975 and 2007.

In the data, there are two trends in entrepreneurship since 1975: the average debt-to-asset ratio among entrepreneurs has increased, and the number of entrepreneurs (the entrepreneurship rate) has fallen. I study how the distribution of wealth changes over time, when these two trends are accounted for in a model.

…[two] channels accounts for both the fall in the entrepreneurship rate and the rise in the entrepreneurs’ leverage: an increase in banks’ willingness to fund risky entrepreneurial projects and a rise in the costs of starting a business. When changes in entrepreneurship are accounted for, my model explains more than 90 percent of the rise in the share of wealth held by the top 1 percent of households, and just under half of the rise in the share of the top 0.01 percent of households in the data.

A lower rate of entrepreneurship implies that a smaller number of households can take advantage of their productive ideas. Active entrepreneurs, however, have access to more capital which allows highly productive entrepreneurs to expand their businesses. Both of these changes contribute to a rise in inequality over time.

Below are two figures from the paper showing the declining entrepreneurship rate and increasing leverage. Mohaghegh doesn’t explain these facts but he connects three literatures, declining entrepreneurship, increasing financialization and rising inequality and he shows that the first two of these well-known features of the US economy can explain a large share of the third, the rise in inequality.


This assumes that entrepreneurs are the main reason for the 1%’s greater wealth, but there was a study a while back showing what professions 1% members are in (https://archive.nytimes.com/www.nytimes.com/packages/html/newsgraphics/2012/0115-one-percent-occupations/index.html?hp) and only a small number of the 1% could plausibly be entrepreneurs. The largest categories are professionals like business managers, doctors, finance workers, and doctors. Additionally, large chunks of the 1% are in professions like secretary and teacher where they could not possibly have achieved 1% status through work, but likely did so through marriage or inheritance instead. It would be interesting to see how much of the increase in wealth inequality is simply due to growing assortative mating or the accumulation of inheritances, which one would expect to grow generation-after-generation if there is enough wealth and stability for most people to die with some wealth. My guess is that marriage and inheritance explain more of growing concentration of wealth at the top 1% than anything relating to entrepreneurship or the labor market generally.

I agree that this study has to demonstrate that the increased concentration of wealth is actually going to entrepreneurs. Otherwise it just seems like p-hacking.

"I agree that this study has to demonstrate that the increased concentration of wealth is actually going to entrepreneurs. "

I'm not sure what the aggregate numbers actually say, so this is a Wag. But just the large entrepreneur equity holders for the biggest new tech firms probably have increased the concentration of wealth.

The US has a large number of first generation multi-billionaires.

That makes sense.

Very few tech startups take on debt, which does not refute the thesis, but dies suggest a deeper look at whether debt is really driving returns to entrepreneurship.

@Zaua - nice NY Times graphic, notice the graphic is measuring both top 1% households and who works in these top 1% households, hence "teachers" do surprisingly well (as do registered nurses and artists) since while their jobs don't make money, these people tend to live with the rich (cute kindergarten rich man's wife, doctor's nurse wife, artist who is a trust baby, by way of example).

As for AlexT's original post, please don't confuse inequality with ability. It's well known that the Fortune 500 gets a disproportionate share of patents, compared to 'mom and pop' outfits (with exceptions that prove the rule, like scientists working at a Fortune 500 who spin-off on their own with IP from the parent company), hence arguably the best and the brightest work at Microsoft, Apple and Google. But not maybe not Walmart, though I'm sure WMT has some very innovative supply chain trade secrets and negotiation tactics (like Boulwarism, I read once a supplier for Walmart asked for a 5% price increase, "or else", Walmart countered with a 5% price decrease, putting the supplier out of business who was then promptly replaced by a Chinese cheaper supplier).

Actually, it isn't clear if the financialization of the economy causes a rise in inequality, or if a rise in inequality causes the financialization of the economy. That question has been asked by economists for decades (i.e., since inequality and financialization began to rise simultaneously). Since the financialization of the economy correlates strongly with financial instability, one must ask whether it's the financialization or the rise in equality that causes the instability. I am pleased that Tabarrok is willing to at least highlight the issue, even if not directly. By the way, if one is interested in history, look at the 1920s, which also experienced a rise in both the financialization of the economy and inequality. Of course, the 1920s ended with the mother of financial crises.

Counselor, look at the NY Times graphic Zaua provided; notice that 'financial services' even if you include accountants and auditors with financial specialists (Wall Streeters), they are a much smaller rectangle than lawyers. Lawyers still rule the 1%, as do of course "Managers" (the biggest block). So Wall Street is not the 'problem', it's the effing lawyers! ;-)

Financial services and financialization are not the same thing. I might ask what is meant by "entrepreneurship". Does it include buying and selling companies? Or is it something more narrow, such as the creative development of a product or business? Does it include speculating on financial assets including currencies? Or is it something more narrow, such as the creative development of a financial asset to market to the wealthy? What the author of this study has done is to define "entrepreneurship" in such as way as to capture anyone or anything that makes large profits. Of course, attributing rising inequality to "entrepreneurship" is far more palatable than attributing rising inequality to inherited wealth and the magic r > g, speculating in financial assets, or staying in close proximity to wealth so that some of it may fall on one. I have no problem with inequality as long as there is no negative consequences to the less equal. Studies like this one elide that question.

Completely anecdotal, but sometime in the '70s I realized that our public educational system was failing and that the wages paid for most blue collar jobs were inflated. I can't remember the constellation of events from which I concluded it was every man for himself, but it was pretty obvious then that the meme of a rising tide lifting all boats wasn't going to protect us from Asia (at the time Japan, S.Korea & Taiwan). My career was not focused on amassing wealth, but I chose a profession which I believed would be comfortably upper middle class. Boy, was I wrong. Now days upper middle class would be what? $300,000? Any "inequality" study which doesn't look at the real expectations of the workers who can negotiate/set their salary is fundamentally flawed.

Summing it up: the American Dream has gone sour, the American system is a fraud.

I've never understood what this claimed "American dream" is. Can you explain?

According to Wikipedia, "The American Dream is a national ethos of the United States, the set of ideals (democracy, rights, liberty, opportunity and equality) in which freedom includes the opportunity for prosperity and success, as well as an upward social mobility for the family and children, achieved through hard work in a society with few barriers. In the definition of the American Dream by James Truslow Adams in 1931, 'life should be better and richer and fuller for everyone, with opportunity for each according to ability or achievement' regardless of social class or circumstances of birth."

@Li - top 1% in income is probably $300k, but this post by AlexT addresses wealth, which is "net worth" and to get into the top 1% in net worth, like my household is, requires a minimum net worth of $10M and above. Not hard to do actually if you live in the DC area; most of my upper middle class neighbors are multimillionaires, even the African-Americans. Not sure if they're in the top 1% like us, but a few households on are block are I'm pretty sure.

It’s anything but “every man for himself” when some are forced to live for others by way of- among other things- government programs benefiting the politicians and their vested interests at the expense of others who have no say including those who voted for the (winning) politician in the first place. The voting of market systems over to political systems prohibits- by default- ANY man living for himself much less “…every man…” doing so.

Zaua, I think you're mixing up inequality in wealth and income. The NYT article you reference concerned inequality in income, where the professions mentioned loom large in the top 1%. (Admittedly, the chart in the article is confusing: the subtitle refers to the "wealthiest households", but the note clarifies that the chart includes those occupations comprising the top 1% of income receivers.) The situation is different for top wealth holders, where entrepreneurs who have started businesses that went to large scale are the main factor in the growth of inequality, as this paper demonstrates. Take a look at the Forbes list of richest Americans for anecdotal evidence.

I've long thought that the rise in 401(k) plans hurt entreprenuership. This savings vehicle locks many middle class families into a more corporate lifestyle as their savings can't be used (easily) to start a new business. It's a large chunk of their non-home assets and is largely unavailable until they are 59. I've never seen a paper or article on this.

It used to be common (at least in Britain) for businessmen to exploit the equity in their houses. Do people nowadays instead exploit that equity to buy gew-gaws?

They do. Prior to 2008 many took out home equity loans to buy toys. Then the sh*t hit the fan, so to speak. So much wailing and gnashing of teeth.

The rise of the 401k occured because companies stopped providing pensions, and unions were weakened and dropped off. Now, in order to survive past retirement, people HAVE to have a 401k. The real question is why did companies stop providing the pension benefit? Are those same companies less profitable now, so they can't afford the margin? Or, is it true that in the empirical case that those margins, instead of going to worker benefits, have accumulated to executives and board members and shareholders?

Companies stopped providing pensions as soon as GAAP changed so they had to properly account for pension benefits. Before that it was easy of Course. Promising workers fantastic wage increases the next CEO over would have to account for and pay was a no-brainer.

Companies stopped providing pensions when they realized pensions cost twice as much as what they had expected, and they were very volatile and poorly-behaved from a balance sheet, income statement, and cash flow perspective, so why would a widget-maker run an insurance game on the side?

Malcolm Gladwell was big on the idea that pensions became a bad deal when the demand for unskilled labor fell, thanks to automation, and companies wound up with more retired workers receiving benefits than they had active workers paying into the funds.

There is something vaguley Ponzi-ish in that formulation. The whole point of pre-funding and accounting for pensions as a part of compensation is to free yourself from this inter-generational dependency, but the actuarial models were broken by 21st century experience.

Trade union ("multi-employer") pensions in the US, along with public sector pensions, aren't forced to adhere to realistic financial reporting, so these pensions still exist, but they are a shambles.

Public sector pensions are what you get when two wolves and a sheep vote on what to have for dinner.


GAAP changed in 1988. In the 1990s, companies loved GAAP and pensions produced corporate income.

'Twas the early 21st century -- double whammy of falling interest rates and falling stock prices -- that killed pensions (for organizations that contend with financial reality.)

I'm more inclined to believe that Pensions were killed off by automation (dropping the relative size of labor costs) and free trade.

As a business automated its work force, the pay roll dropped. However, an existing firm with lots of Pensions still had a sizable "payroll" that was based upon the legacy of pre-automation. Essentially employees that were replaced due to automation, were still being paid via the companies requirement to keep making pension contributions for them. They couldn't compete with new firms (or overseas factories) that didn't have that added legacy cost.

Falling interest costs tended to increase the adoption rate of automation of course. But that's a secondary effect.

The first order effect of falling interest rates is to swell pension liabilities and costs.

Fundamentally, a pension is an opaque and difficult to value means of compensation. Companies don't want to underwrite open-ended commitments, particularly after the experience of the early 21st century. They want to know how much something will cost.

Some employers still make pensions work: banks, insurers (financial intermediaries- core competency?) oil and gas (long-lived corporate assets?)

In poor governance contexts (public sector), opacity is a feature, not a bug.

"The first order effect of falling interest rates is to swell pension liabilities and costs."

Agreed, but there were periods of falling interest rates before the 1990's.

Fundamentally there were new issues that made companies with Pension plans non-competitive with companies without. Frankly, it probably wasn't automation. Automation has been a strong factor for 150 years. It was Free trade that constrained manufacturing companies ability to pass high wage costs along to their customers.

It may not be a coincident that Pensions started declining in the private sector during a period of increasing free trade and deregulation. The final straw was probably NAFTA.

"Some employers still make pensions work: banks, insurers (financial intermediaries- core competency?) oil and gas (long-lived corporate assets?)"

All companies that are protected from overseas competition.

That's an interesting theory.

That's an interesting comment. Personally, I feel awfully illiquid relative to my wealth because so much is tied up in tax advantaged accounts that come with heavy restrictions on their use.

The NYTimes is looking at income inequality rather than wealth inequality, but 401(k)s and changes in the tax system have made the corporate life a better path to mild wealth than it was back when, say, The Millionaire Next Door was written. Go back to that era and there were minimal tax advantaged savings vehicles, income was heavily taxed, and entrepreneurship was a license to write off life expenses on your taxes. Today, income taxes are flatter, tax-advantaged/locked-up accounts abound, and entrepreneurship is more rigorously taxed. It's not surprising that it's easier to become mildly wealthy by having a professional career (doctor, lawyer, engineer, professor), and relatively (maybe absolutely) harder by being an entrepreneur than it once was.

I borrowed against my 401k for my first home down payment.

You can take out Roth contributions as well. I'm not illiquid, I'm illiquid relative to my wealth. To depersonalize it, it's easy to have a seven figure IRA and 529 account balance and not be able to front $500k for a startup.

For that matter, as is probably closer to reality for me, financing early retirement in my fifties would be tricky from a tax perspective.

If you take a "series of substantially equal payments" from the plan, you avoid the 10% excise tax.


Use taxable accounts to finance the first few years. We sold one property to pay for the first 5 years living expenses. We've extended the first tax advantage account withdrawal another few years by spending less than projected.

You can also use a self directed IRA

Don't forget employer-locked health insurance.

The ACA solved that problem. Get with the times!

It could have, if the two sides could stop fighting long enough to actually try to fix a problem.

Does this also explain wealth inequality in other countries? Italy, Canada and Germany also seem to have increasing rates of inequality, but I don't tend to think of them as entrepreneurial juggernauts. If not, then how are they different?

The entrepreneurship rate went down in all those places. Entrepreneurs are often younger and more likely minorities, but the Western countries have grown older and closed down immigration except Canada.
The best paper I've read about the topic is adamant that only wars and the resulting asset destruction really reduce inequality. Otherwise inequality broadly increases at all times. If you think of it, most people are financially more or less responsible; with compound interest a small advantage in initial wealth will compound many times over. Those families never need to tap into the substance.
The main difference between Italy, Canada, Germany and the US is the personal income tax though. In Germany, you get to keep less than half your income even if you're upper middle class (top taxes are the income tax, VAT, mandatory health insurance with negative expected value, mandatory pension insurance with negative expected value, corporate taxes, capital gains taxes on top of those, the inheritance tax, and many lesser taxes such as income-adjusted penalties for speeding).

"most people are financially more or less responsible; with compound interest a small advantage in initial wealth will compound many times over"

LOL no

By the way U.S. and EU have fairly similar taxes on high incomes. It's middle-income earners who have much lower taxes in the U.S.

yeah, true. I was thinking about financially responsible families passing down savings from one generation to the next, but it's plausible that this is a minority.
Doesn't the relatively high-ish tax on low and middle income in EU (we forgot their VAT, cigarette and gas taxes which are all highly regressive) do well in preventing upper middle class Folks (doctors, Finance people) from graduating from middle class and becominq rich in Europe, while this channel is relatively better incentivized in the US, then? Most of the rich people I know, anecdotally, are not doctors or Finance people, but they rather work for the EU, which makes its own ridiculously low tax rules.

If or when we tire of egalitarian pieties, perhaps possibly maybe someone will coin "democratic capitalism" to begin appealing to those enamored of so-called "democratic socialism".

Meantime: egalitarian pieties seem increasingly capable of yielding only untethered utopian politics.

Why do our cognitive elites (who as a class DO NOT PRACTICE [hence, DO NOT BELIEVE IN] egalitarianism) persist with their endorsements of egalitarianism?

When does the distance between polite discourse and brutal political and economic reality begin to disabuse us all of the cruel lie that is egalitarianism?

Is the decline of entrepreneurship related to the rise in the number of college students and college graduates? Am I crazy for thinking that earning a BA discourages entrepreneurship?

An accounting professor once told me that his Russian students (studying in the USA) were usually either A or C students. Oddly, he said, the most successful after college were more often the C students, who were more likely to start their own businesses.

Although I havent read the paper and only the findings, I would curious to see how these conclusions hold up over time. To see if they do hold up, I would look at the period where wealth inequality was at its peak, in the mid-1930's. If data can be obtained in this period and the same conclusions can be drawn, than this study truly is significant.

As an entrepreneur myself, I would say that firm formation and failure is down due to much better information about how to successfully run a firm being easily available. When I started in the 80s, it was very difficult to acquire knowledge about anything, and much harder to manage a new company, both financially and in terms of human capital. Nowadays useful knowledge is everywhere, instantly available, and largely free. Tools for management have proliferated and are easily acquired and deployed. So fewer firms fail, and those that are succeeding leave less space in the market for new entrants. Entrepreneurs who might have started several firms stick to one. Employees who, disgusted by incompetent leaders, might have left to start their own firms stay instead because there are fewer terrible bosses. I've never seen anyone discuss this - probably because it's never occurred to academics who lack extended experience in starting and running companies.

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