Can Income Diversification Explain the Growing Entrepreneurship Gap by Age?

Abstract

Entrepreneurship has declined among households younger than 50 years, while it has grown among older households over the past few decades. We hypothesize that this divergence results from younger households having less diversified income from sources unrelated to business income such as capital income and annuity income than is the case for older households. Using data from the Federal Reserve’s Survey of Consumer Finance, we calculate descriptive and multivariate statistics. We find that income diversification from capital income has declined for both younger and older households, while the role of income diversification in people working as entrepreneurs has fallen among younger households and stayed constant among older ones. We also find some tentative evidence that income diversification from Social Security and annuity income plays a role in determining entrepreneurship for older households, but has no effect among younger households. Our results suggest that cash income, unrelated to risky business income, plays a crucial role in determining entrepreneurship and could explain the divergent entrepreneurship experience between younger and older households.

Keywords:

• entrepreneurship
• capital income
• Social Security benefits
• income diversification

Notes

¹ Authors’ calculations based on BOG, Federal Reserve System (2015).

² All numbers in this paragraph are authors’ calculations based on BOG (Various years).

³ The regression may include an endogenous explanatory variable. To test for this, we instrumented capital income using changes in a household’s position in the overall wealth distribution from the previous survey year to the current survey year. Statistical tests suggest that this is a strong instrument. We then use Wooldridge’s (2014) proposed bias correction and include the residuals from the first stage in our regression. The residuals are not statistically significant and there is no statistical evidence of an endogeneity bias. We thus proceed without instrumented explanatory variables.

⁴ The SCF asks “which of the statements … comes closest to the amount of financial risk that you are willing to take when you save or make investments?”, allowing respondents to choose from “Take substantial/above average/average financial risks expecting to earn substantial/above average/average returns” and “Not willing to take any financial risks.” We combine answers indicating above average and substantial willingness to take risks.

⁵ The parameter estimates as well as standard diagnostics are available from the authors upon request.

⁶ Other estimates have the expected signs or are statistically insignificant.

⁷ Older entrepreneurs have become more likely than wage and salary employees to have substantial capital income. Only 15.7% of older wage and salary employees had substantial capital income in the early years, and 104% did in the later years. Authors’ calculations based on BOG, Federal Reserve System (Various years).

⁸ Details available from authors upon request.