Entrepreneurship, Asymmetric Information, and Unemployment

The paper examines how asymmetric information affects the supply of entrepreneurs and the level of unemployment. The model first analyzes the case where banks, when providing credit, are unable to observe entrepreneurs' risk of failure. We find that credit rationing may increase the number of entrepreneurs and the level of unemployment. The second source of asymmetric information arises in the labor market when firms are unable to observe workers' supply of effort. Firms then offer a wage above the market clearing one (i.e., an efficiency wage) to encourage effort. This type of asymmetric information prevents the labor market from attaining a full employment equilibrium and results in too few entrepreneurs. The final source of asymmetric information examined arises when firms cannot observe workers' abilities. Firms then offer a single wage that lies between the wages obtained by the higher and lower ability workers with full information, and results in too many entrepreneurs. The paper first examines the implications of asymmetric information for the level of unemployment and an individual's occupational choice. Next, the paper explores the optimal role of government in restoring efficiency and, in particular, determines in which market--labor or capital--government intervention is most effective