Persistency of Poverty, Financial Frictions, and Entrepreneurship

Do …nancial constraints have persistent e¤ects on the creation of businesses, or should we expect that forward-looking individuals always save their way out of credit constraints? This paper studies the interaction between savings and the decision to become an entrepreneur in a multiperiod model with borrowing constraints to answer this question. The model has a simple threshold property: able individuals who start with wealth above a threshold save to become entrepreneurs, while those who start below this threshold remain wage earners forever. The threshold wealth such that able entrepreneurs …nd it bene…cial to save decreases with entrepreneurial ability, i.e., the magniture of individual poverty traps decreases with entrepreneurial ability. Still, calibrated examples show that the magnitude of individual poverty traps can be large, specially if returns to scale are calibrated to be large. I thank Fernando Alvarez, Gary Becker, Mariacristina De Nardi, Xavier Gine, Boyan Jovanovic, Joe Kaboski, Robert Townsend and Iván Werning for valuable comments and suggestions. I also bene…ted from comments of participants at various seminars. E-mail: [email protected]