DP2534 Redistribution as a Selection Device

Author(s): Hans Peter Grüner
Publication Date: August 2000
Keyword(s): Education, Firm-Ownership, General Equilibrium With Moral Hazard and Adverse Selection, Selection Of Entrepreneurs
JEL(s): D31, H23, H32
Programme Areas: Public Economics
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=2534

This paper studies the role of the wealth distribution for the market selection of entrepreneurs when agents differ in talent. It argues that the redistribution of initial endowments can increase an economy's surplus because more talented individuals get credit for their risky investment projects. Moreover, the redistribution of initial endowments may lead to a Pareto-improvement although all agents are non-satiable. In my model an agent's entrepreneurial ability is his private information. Moral hazard in production creates rents for entrepreneurs if they are believed to be both talented and willing to provide entrepreneurial effort. I find conditions such that unproductive rich entrepreneurs crowd out productive poor ones on the capital market. Then redistribution of initial endowments leads to the selection of better entrepreneurs, increases the economy's surplus, and - in some cases - makes all agents better off.