Optimal subsidization of business start-ups

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Official URL: http://dx.doi.org/10.1111/jpet.12194

This paper studies efficient allocation of resources in an economy in which agents are initially heterogeneous with regard to their wealth levels and whether they have productive ideas or not. An agent with an idea can start a business that generates random returns. Agents have private information about (1) their initial types, (2) how they allocate their resources between consumption and investment, and (3) the realized returns. I show that, under informational frictions, a society that targets productive efficiency should subsidize poor agents with ideas, and choose the amount and timing of subsidies carefully in order to ensure that other agents do not mimic poor agents with ideas and receive subsidies. Then, I provide an implementation of the start-up subsidies in a market framework that resembles the U.S. Small Business Administration's Business Loan Program.