Thailand provides a unique
backdrop in which to examine connections between growth and income inequality.
Data show that as the Thai economy grew rapidly between 1976 and 1996,
inequality increased and then decreased. Research indicates that a substantial portion
of this trend of changing inequality is explained by population shifts across occupational
subgroups and associated changes in income gaps; for example, business is a
high yield occupation while subsistence earning is a comparatively low yield
occupation. Population shifts across sectors are considered to be the driving
force of the relationship between growth and income inequality, so it is
important to understand how individuals choose their occupations.
In order to learn more about
self-selection, Jeong and Townsend (2005) utilize the theoretical framework
of occupational choice proposed by Lloyd-Ellis and Bernhardt (2000). At the
micro level, we may imagine an economy comprised of subsistence earners, wage
earners, and entrepreneurs. Do individuals choose their occupation randomly? Does
an individual's initial wealth influence his occupational choice? For instance,
we might expect a wealthy individual to start a business, while a poor individual
may choose subsistence work or wage labor. In the absence of access to -- and
use of -- financial institutions, this theory may be effective in predicting
occupational choice. In this discussion, we examine what factors lead individuals
to choose their respective occupations.
The Lloyd-Ellis and Bernhardt
(LEB) model proposes that each individual is endowed with a certain level of
"talent", manifest in the ability to lower the fixed costs of running a
business. Ideally, all individuals possessing a high level of talent would want
to start a business in order to maximize profits. However, to do so, such
talented entrepreneurs most often face an initial cost or investment. Similar
financial demands are present for existing entrepreneurs; a talented entrepreneur
who has the potential to earn higher returns by expanding his business will
likely face costs or investment associated with such an expansion.
In both starting and expanding a
business, individuals will remain inefficient if they lack access to finance. In
the instance of starting a business, a talented, would-be entrepreneur who
lacks adequate capital or credit must instead choose between wage work and
subsistence farming, despite his ability to earn more if he could run his own
business. Similarly, in the absence of a credit market, a talented entrepreneur
is unable to scale his business correspondent to his talent and thus earns
below his potential.
Less talented entrepreneurs who
have financial means may be able to start and expand a business. However, it is
quite plausible that in this instance an individual may actually enjoy higher
returns by saving the money in the bank and earning interest, given his low
level of talent. In the absence of a financial system that facilitates savings,
scaling up actually causes this individual to earn less than what he could have
had he been able to combine the profits of his business and the interest earned
from savings.
These scenarios illustrate that
in the absence of a credit sector, or financial intermediation[1], a
disparity between talent and occupation exists. Thus, in the absence of financial intermediation, initial wealth, not talent, becomes a significant determinant of
occupational choice. As a result, low wealth renders a talented individual
unable to start a business and a talented entrepreneur unable to run his
business at an efficient scale.
From this work, we draw the
lesson that savings and wealth accumulation, as well as improved
financial intermediation, are strategies that can overcome credit constraints
in the long run. These strategies can reduce inefficiency in the
economy, allowing individual characteristics to drive occupational choice,
rather than initial wealth.
To read more about occupational choice, visit Cambridge
Journals for an abstract and full PDF version for subscribers.
[1] Financial intermediation constitutes all the
activities linking borrowers and lenders. It is often measured by the amount of
the intermediated credit or by the number of people who use credit services.
Photo by Gusjer.
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