Wage Inequality and Barriers to Entry Preliminary and Incomplete

This paper provides a theory of wage inequality that hinges on entrepreneurship. The theory is motivated by new empirical findings. Among them, I document that in countries where barriers to entrepreneurship are high, wage inequality is low. As noted in the literature, differences in wage inequality across countries are, to a great extent, determined by differences in the skill premium, defined as the ratio between the wage of college graduates and that of workers with at most a high school diploma. A high degree of education has been found to be a salient characteristic of people who are entrepreneurs. In a world in which skilled people can choose between a wage job and entrepreneurship, barriers to entry reduce the value of entrepreneurship and lower skilled workers’ outside option. I formalize this idea in a simplified model of firms dynamics à la Hopenhayn (1992a) in which I introduce occupational choice in a general equilibrium setting. The model is parametrized on the entry rates of firms in the United States to match the observed skill premium assuming the cost of entry is zero. In a counterfactual exercise, the cost of entry in Italy is backed up by matching the entry rates in this country. Under the Italian entry rate, the model predicts for the U.S. a skill premium twenty percent lower than the actual one, accounting for more than forty percent of the difference in the observed skill premium between the two countries.