Scalable vs. Productive Entrepreneurship and Wealth Inequality

Title:  Scalable vs. Productive Entrepreneurship and Wealth Inequality ( with Mons Chan, Guangbin Hong, Serdar Ozkan, and Sergio Salgado)

Abstract: Do larger firms have more productive or more scalable technologies? Are wealthy households more likely to invest in one over the other? We estimate nonparametric production functions using balance sheet data on the universe of Canadian firms, resulting in a joint distribution of input elasticities—therefore, returns to scale (RTS)—along with total factor productivity (TFP). We show that larger firms are characterized by significantly higher RTS, even within narrow industries. We also find that wealthier households are more likely to own firms with higher RTS. However, the relationship between TFP and firm size is more nuanced. As an application, we show that misallocation from financial frictions is more severe when the observed firm heterogeneity is driven by RTS differences, compared to the conventional view that attributes firm heterogeneity entirely to TFP differences. We develop a quantitative equilibrium model where entrepreneurs operate technologies differing in RTS and TFP. The estimated economy with both RTS and TFP heterogeneity shows efficiency losses over 100% larger than a calibration allowing only TFP heterogeneity.