Working Papers

September 1997, No. 97-9

Entrepreneurship and Government Subsidies Under Capital Constraints: A General Equilibrium Analysis

Wenli Li

This paper studies the interaction of capital constraints with business formation, growth and destruction, and the policy implications of this interaction. A dynamic general equilibrium model is constructed and shown to be consistent with recent empirical finding on this subject. In the model, agents face uninsurable income risk and costly financial intermediation, and they choose to be either a worker or an entrepreneur. A calibrated version of the model is used to examine two government assistance programs: loan guarantees and grants. The main findings are that both programs can improve welfare and that grants outperform the more popular loan guarantees.

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