Entrepreneurs, moral hazard, and endogenous growth

We analyze an endogenous growth model with agents differing in their endowments. Poor entrepreneurs with limited liability need to borrow in financial markets to participate in aggregate output production. We show that the first-best solution can either be achieved by decentralized financial contracting or by employing a project-specific subsidy policy. If additional capital market imperfections are introduced into the model, a negative link between inequality and growth emerges. Then, the impact of inequality on growth increases for a higher degree of frictions. (C) 2004 Elsevier Inc. All rights reserved.