Self-Employment and Labor Turnover : Cross-Country Evidence

The share of the workforce in self-employment and the level of turnover are shown to be unreliable measures of labor market distortion and rigidity. Both are shown to be more affected by standard economic and demographic variables - the level of formal sector productivity, real interest rates, and education levels - than by labor taxes and barriers to firing.Maloney uses cross-country data from Latin America and OECD countries to test the predictions of a simple efficiency wage model (Krebs and Maloney 1998) about the share of the workforce in self-employment and the rate of labor turnover across the process of development and demographic transition. The model is supported, with numerous demographic, economic, and labor market institutions appearing as important determinants of both self-employment and turnover. Social security taxes on firms and barriers to firing workers appear to reduce the size of the formal sector, and barriers to firing do appear to reduce turnover. But the level of formal sector productivity, real interest rates, and education levels generally have a greater impact.A central lesson is that it is misleading to use the size of the informal self-employed sector and the rate of labor turnover as indicators of distortion or rigidity without first adjusting for these factors. Somewhat speculatively, Maloney offers adjusted measures that suggest that Latin American labor markets are not especially distorted and are about average in flexibility, with important exceptions. Central to the theoretical framework is the view that self-employment is a desirable destination for many salaried workers rather than the disadvantaged sector of a labor market segmented by union- or government-induced rigidities. To prevent the loss of investment in training to the informal sector, firms will pay above-market-clearing efficiency wages, in the process creating unemployment or segmentation that may cut across lines of formality.This paper - a product of the Poverty Reduction and Economic Management Unit, Latin America and the Caribbean Region - is part of a larger effort in the region to understand the functioning of developing country labor markets and the impact of labor legislation