Self-Employment and Labor Turnover in Developing Countries: Cross-Country Evidence

This article argues that neither the share of the workforce in self-employment nor the labor turnover rate are useful measures of labor market distortion or rigidity unless adjusted for country-specific economic and demographic variables. A growth model that incorporates efficiency wage effects and offers an alternative to traditional models of informal self-employment is developed and is used to generate predictions about the determinants of both measures. These predictions are supported by cross-country data from Latin America and the Caribbean (LAC) and the Organisation for Economic Co-operation and Development (OECD) countries. Though somewhat speculative, the data further suggest that Latin American labor markets may be neither especially rigid nor distorted. This article develops and tests an integrated approach to understanding two outstanding questions central to the analysis of labor markets in developing countries and the impact of labor legislation. Though the article focuses primarily on Latin America, the issues and analysis are germane both to other developing countries and to industrial countries. My thanks to Wendy Cunningham, Norman Hicks, Tom Krebs, Guillermo Perry, and Martín Rama for helpful comments. Special thanks to Kihoon Lee for able research assistance. 138 William F. Maloney The first issue is the role of the large informal sector in the region (see table 1). A traditional view argues that the sector testifies to government or union-induced rigidities that force formal remuneration above market clearing and that ration workers into informality.1 This article argues that this view is probably incorrect and that it is difficult to draw any conclusions about labor market efficiency from sector size alone. The second question centers on what recent findings of high turnover, a common measure of rigidities (see, for example, Nickell 1997), imply about the flexibility of labor markets in the region.2 It is often asserted that high firing costs and excessive benefits in the formal sector prevent the efficient allocation of workers among jobs.3 However, as table 1 suggests, average tenure is shorter, and a larger fraction of the workforce has been employed in their current position for less than two years in Latin America than in the Organisation for Economic Co-operation and Development (OECD). This article argues that this probably cannot be interpreted a priori as evidence of greater flexibility. The first section, “Motivation and Theoretical Overview,” heuristically develops a model that moves beyond the standard segmentationbased view of the relationship of formal and informal sectors, and incorporates the increasing evidence that a large fraction of the employment in the informal sector is voluntary. It is developed in an efficiency wage context both because recent evidence suggests that much observed segmentation may arise endogenously rather than being imposed by labor unions or minimum wages, and because it permits explicit modeling of the determinants of turnover. Predictions can be made about how the size of the self-employed sector, the degree of segmentation in the market, and turnover should move with the development process and policy innovations. The next section, “Cross-Sectional Regressions,” examines crosscountry data from Asia, Europe, and Latin America with three objectives. The first two are straightforward: to test the predictions of the model about the size of the informal sector and rates of turnover with respect to several key labor market, productivity, and demographic variables suggested by the theoretical framework; and to suggest the 1. See Harris and Todaro (1970) for an early presentation of this view. 2. See Maloney (1999) for Mexico; Gonzaga (1996) for Brazil; Anderson Shaffner (1997) for Colombia; and Márquez and Pagés (1998) more generally. 3. See for example Burki and Perry (1997). SELF-EMPLOYMENT AND LABOR TURNOVER IN DEVELOPING COUNTRIES 139 direction of possible influence of variables that are theoretically ambiguous. Somewhat speculatively, however, the article also attempts to provide more informed estimates of the incidence of immeasurable distortions that ration more workers into the informal sector, or rigidities that decrease turnover. Since our theoretical framework abstracts from such exogenous phenomena, we tentatively measure their impact by the deviations from the model’s predicted values. Although it is trivial to raise objections to this approach on either theoretical or empirical grounds, the results at once strongly coincide with the stylized facts about industrial countries, and challenge what is commonly thought about Latin America: with some predictable exceptions, regional labor markets do not appear unusually distorted or inflexible. Motivation and Theoretical Overview The empirical work here is motivated by a macroeconomic model based on microbehavior of workers described in detail in Krebs and Maloney (1998). It is built in a growth context so that secular movements in labor productivity can be incorporated, and it makes predictions about movements in formal and informal sector employment, the degree of market segmentation, and labor turnover rates across the course of the development process. It also attempts to incorporate two emerging stylized facts about labor markets in developing countries. 1. The informal sector is extremely heterogeneous and contains both voluntary and involuntary members. The informal sector is frequently considered the disadvantaged sector of a labor market segmented by government or union intervention in the formal sector wage-setting process.4 During downturns, the sector is thought to expand as it absorbs displaced workers and then to contract again with recovery. TABLE 1. SIZE OF INFORMAL SELF-EMPLOYMENT AND TURNOVER RATES