Citation
Levine, R., & Rubinstein, Y. (2016). Smart and Illicit: Who Becomes an Entrepreneur and Do They Earn More? Quarterly Journal of Economics, 131(2), 963-1018. https://doi.org/10.1093/qje/qjw044
Context and Motivation:
The paper investigates the characteristics that distinguish entrepreneurs from other types of self-employed individuals and salaried workers, specifically focusing on incorporated versus unincorporated business owners. The study seeks to understand the cognitive and noncognitive traits of entrepreneurs and their impact on earnings compared to their salaried counterparts.
Key Concepts and Definitions:
- Entrepreneurs: Defined in this study as the incorporated self-employed, who tend to engage in businesses requiring high cognitive skills and are structured to limit personal liability and enhance growth potential.
- Unincorporated Self-Employed: Individuals who manage smaller-scale operations, often requiring less cognitive and more manual skills, without the legal protections of incorporation.
- Cognitive and Noncognitive Traits: Cognitive traits refer to intellectual capabilities, often measured by aptitude tests, while noncognitive traits involve personality aspects like self-esteem and illicit behavior during youth.
Main Findings:
- Traits of Entrepreneurs: Incorporated entrepreneurs generally have higher education levels, exhibit higher scores on learning aptitude tests during adolescence, and possess greater self-esteem. Interestingly, they also display higher tendencies toward engaging in illicit activities during youth.
- Earnings Comparison: Entrepreneurs (incorporated self-employed) tend to earn significantly more than both unincorporated self-employed individuals and salaried workers. This earnings advantage is observed across the distribution of income but is associated with higher earnings variability.
- Impact of Entrepreneurship on Earnings: Transitioning from salaried employment to entrepreneurship generally results in a substantial increase in earnings. This holds true across various income deciles and emphasizes the economic benefits of entrepreneurial ventures.
Data Sources:
The study utilizes data from the U.S. Current Population Survey (CPS) and the National Longitudinal Survey of Youth (NLSY) to analyze the background and outcomes associated with different types of employment.
Methodological Approach:
The authors employ regression analyses to identify the relationships between being an entrepreneur and various outcomes, controlling for a range of demographic and psychological factors. The distinction between incorporated and unincorporated business is a central aspect of the analysis, allowing for a nuanced understanding of what constitutes entrepreneurship.
Evaluation of the Study
Strengths
- Robust Methodology: The paper effectively uses large, longitudinal datasets (CPS and NLSY), which enhances the reliability of its findings. The choice to differentiate between incorporated and unincorporated self-employed individuals allows for a more nuanced analysis of what truly constitutes entrepreneurship.
- Detailed Trait Analysis: By examining both cognitive and noncognitive traits, the paper goes beyond traditional economic analyses that focus solely on observable characteristics like education and income. This approach sheds light on the psychological profile of entrepreneurs, including the intriguing link between early illicit behavior and later entrepreneurial success.
- Comprehensive Earnings Analysis: The study’s focus on earnings across different quantiles provides a detailed picture of the financial outcomes associated with entrepreneurship. This approach is particularly valuable in understanding the full economic impact of becoming an entrepreneur.
Weaknesses
- Generalizability: While the findings are robust within the context of the United States, it’s unclear how well they generalize to other cultural and economic contexts. Different countries may have varying definitions of entrepreneurship and distinct legal and business environments that could alter the relationship between entrepreneurial traits and success.
- Potential Confounding Variables: While the study controls for many variables, there could still be unobserved factors influencing both the decision to become an entrepreneur and the associated earnings. For example, the network effects and social capital, which are not directly measured, might play a significant role in entrepreneurial success.
- Causal Inference: The paper provides strong correlational data, but the causal relationship between entrepreneurial traits and success is more challenging to ascertain. The analysis does not fully address whether the traits identified lead to entrepreneurial success or if successful entrepreneurs develop these traits through their experiences.
Potential Biases
- Survivorship Bias: The analysis might be influenced by survivorship bias, as it primarily focuses on entrepreneurs who have remained in business long enough to be captured in surveys like the CPS and NLSY. This could skew results toward more successful entrepreneurs, overlooking those who may have failed early.
- Reporting Bias: Self-reporting in surveys can lead to biases, particularly with sensitive information like income and illicit activities. Entrepreneurs might underreport earnings due to tax considerations or overestimate them due to social desirability biases.
Overall Impact
The paper contributes significantly to the economic literature on entrepreneurship by highlighting the distinct traits and earnings profiles of entrepreneurs compared to other self-employed individuals and salaried workers. Its findings could influence public policy, particularly in crafting support systems for entrepreneurs and understanding the pathways to entrepreneurial success. The study also opens avenues for further research into the noncognitive aspects of entrepreneurship, which could lead to more targeted educational and developmental programs to foster entrepreneurial skills.
Future Directions and Recommendations
1. Further Research into Noncognitive Traits:
The association between illicit activities and entrepreneurial success is provocative and warrants deeper investigation. Future studies should explore the causal mechanisms underlying this relationship and consider a broader array of noncognitive traits.
2. Policy Development:
Policymakers should consider how education and training programs can nurture entrepreneurial skills, possibly by promoting calculated risk-taking and problem-solving abilities, without encouraging unethical behavior.
3. Educational Implications:
Educational institutions could refine curricula to better prepare future entrepreneurs by incorporating lessons on both cognitive skills like analytical thinking and noncognitive skills like resilience and self-confidence.
4. Investor Strategies:
Investors might benefit from considering the broader profile of an entrepreneur, not just their business plan or model but their noncognitive traits, which might predict an ability to navigate the uncertainties of entrepreneurship.
5. Support for Unincorporated Self-Employment:
Given that unincorporated self-employed individuals do not show the same earnings advantage as incorporated entrepreneurs, there could be targeted support to help these business owners increase their success rates and earnings.
6. Expanding Demographic Research:
The study could be expanded to include more diverse demographics and economic backgrounds to understand how the intersectionality of identity and socio-economic status influences entrepreneurship.
7. Causality Exploration:
While the study provides correlational data, experimental or quasi-experimental designs could offer insights into causality, helping to understand whether and how specific traits can be developed to enhance entrepreneurial outcomes.
8. Cultural and Temporal Relevance:
The study could be replicated with newer cohorts and in different cultural settings to verify the relevance of the findings over time and across various societal norms.
9. Entrepreneurial Lifecycle Studies:
Research might also focus on the entire lifecycle of entrepreneurship, from inception to exit, to identify the stages at which certain traits become most critical and how they affect long-term outcomes.
By pursuing these directions, future work can build on the foundation laid by Levine and Rubinstein to enhance our understanding of entrepreneurship and its role in economic development and personal fulfillment. It is crucial to remember that entrepreneurial success is multifaceted and influenced by a dynamic interplay of personal traits, market conditions, and broader economic policies.