This paper argues that, contrary to conventional thought, the market development of the institutional environment not only lowers constraints to entrepreneurship, but in addition, encourages those of higher ability to choose entrepreneurship through an increase in expected returns. The data exploits a natural experiment to explore the transition to entrepreneurship using a differences-in-differences approach (over time and across regions). The results provide evidence that the greatest increase in entrepreneurship after the 1999 constitutional amendment (which made illegal prior discriminatory policies preventing the growth of entrepreneurial firms) was among the top quartiles of the ability distribution. The findings suggest that the selection of high quality individuals into entrepreneurship is shaped less by the relaxation of constraints such as the costs of entry and more by the risk/return profile of founding a firm. In addition, both developing and developed countries may want to consider institutions that encourage high human capital individuals to enter entrepreneurship since their firms are found to have higher productivity and to be more innovative. This paper analyzes unique data from a recently conducted survey of alumni graduating from 1947-2007 from a technical university in China.
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