The Pervasiveness of Self-Employment

Abstract

This chapter questions the view that the costs of social security and health benefits result in lower in-hand payouts in the formal sector and these are not valued by workers as there are weak linkages between benefits and contributions and they would prefer that such benefits be substituted with monetary remuneration. In this case it is the attractiveness of informal self-employment where remuneration can be structured flexibly that causes enterprises in the formal sector to pay above market-clearing wages which in turn reduces the vacancies a firm may create as well as impact on informality. In this understanding it is the pull of the informal sector that forces firms in the formal sector to pay above market-clearing wages so as to retain workers. We contradict this by pointing out that the meagre income of the dominant part of the workforce that is self-employed implies that it is not a form of employment that is voluntarily chosen or preferred. We contrast this with our approach where self-employment is due to accessing resources in the social network by self-employed enterprises that enable them to reduce the cost of opportunism and shirking and thereby to pay lower wages than in the formal sector. High unemployment rates or low rates of job creation in the formal sector or high discount rates of individuals we show induce individuals to accept such self-employment contracts. The informal sector we maintain stresses mutual and joint liability for the success of the enterprise in the sense that if one member shirks then all members of the enterprise are affected as joint performance is the strength of the enterprise. The individuals in a self-employed enterprise participate in a joint contract that promotes more effort by all as only by reducing the costs of shirking do they have an advantage over individual contracts in the formal sector that pay efficiency wages to deter shirking. By stressing joint liability, the self-employed enterprise is able to add value compared to the alternative contracting that targets the individual alone outside her social setting. An implicit contract where co-workers monitor opportunism makes informal self-employment an economic proposition that survives by paying lower wages than formal firms. These lower wages are acceptable over queuing and search for meagrely available formal jobs, high unemployment rates, or high discount rates of individuals. Informal self-employment cushions individuals from unemployment and possible destitution.