Consistent Estimates of the Wage Equation When Individuals Choose among Income-Earning Activities

Abstract

One of the most stable relationships in economics is the human capital determination equation. Numerous studies, using data from the U.S. as well as low income countries, have found that education raises the individual's rate, and that experience affects rates in a non-linear way, peaking in the age cross-section generally at around thirty years of experience. The wage rate is an aggregate concept, in that it represents the returns per hour of work regardless of the type of work performed. This paper is a first step toward a disaggregation of according to income-earning activities. The activities distinguished here are work in the labor market, and vork in self-employment. These activities earn respectively wages and wages, but this nomenclature does not imply that work in self-employment is an activity outside the labor market: self-employment is an individual's choice among labor market alternatives. The motivation for this paper is three-fold. First of all, current literature has not explored in any depth the issue whether the determinants of the rates earned in the two activities are similar. Differences may well exist: entrepreneurial human capital varies from that of employees; the mix of pecuniary (wage) and non-pecuniary compensation may differ; entrepreneurs frequently use their own assets like land or capital in their business activity. Section II will expound on these theoretical differences in more detail. Second, little is known about self-employment wages. Most studies admit to the different nature of the two activities by omitting all individuals reporting self-employment earnings from the sample, and estimate equations for employees only. This is not the optimal solution to the problem: in developing countries up to one half of the labor force is self-employed, and even in industrialized countries 10 to 15 percent adds up to a sizeable group in absolute numbers.' Restricting the sample to employees is likely to intro-