Entrepreneurship and government subsidies: A general equilibrium analysis

This paper quantitatively studies the effects of government credit subsidies. We find that current credit assistance programs in the form of interest subsidies exert strong effects on the allocation of credit to targeted entrepreneurs, but at the cost of nontargeted entrepreneurs. Total entrepreneurial activities are reduced and large output loss is incurred. The paper also examines several alternative credit programs. Our analysis suggests that income subsidy programs and programs that specifically target poor and capable entrepreneurs are more effective in promoting entrepreneurial activity and improving total output. These findings are based on a model with a large number of infinitely lived agents whose saving behavior and occupational choice are influenced by precautionary saving motives and borrowing constraints. Government credit subsidies, on the benefit side, enhance the liquidity of agents by providing an additional means of smoothing consumption and by effectively loosening borrowing constraints. On the cost side, these subsidies and resulting taxes crowd out capital and have adverse incentive effects. Crown Copyright (C) 2002 Published by Elsevier Science B.V. All rights reserved.