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Small Business Economics

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31-08-2019

Self-employment earnings premiums/penalties and regulations: evidence from developing economies

Authors: T. H. Gindling, Nadwa Mossaad, David Newhouse

Published in: Small Business Economics | Issue 2/2020

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Abstract

This paper investigates the relationship between countries’ regulatory environment, as measured through business, credit, labor and trade regulations, and the wage premium or penalty associated with self-employment over the period of 1970 to 2011. When considering all self-employed workers, there is no evidence that labor market regulations are associated with overall earnings penalties or premiums. However, stricter business regulations and bureaucratic red tape that restrict starting, operating, or closing a business are associated with increased earnings penalties for non-professional own-account self-employed workers, as well as premiums for employers and own-account professionals. Both more regulated trade and increased credit availability are correlated with increased earnings penalties for all self-employed workers. The association is consistently larger and more robust for female self-employed workers compared to men. These findings are consistent with regulatory restrictions on business entry and access discouraging more productive workers, particularly women, from entering non-professional own-account self-employment.

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A review of the theoretical literature on self-employment wage differentials and the relationship between regulations, informality, and self-employment is presented in the online appendix.

For a detailed review of the literature see Micco and Pagés (2006) and Djankov and Ramalho (2009).

Tax wedge is defined as the difference between the salary before and after taxes (take-home pay) of an average worker.

Most published studies conclude that self-employed workers do not earn less than equally qualified formal sector wage and salaried employees. However, most of these studies are from middle-income and/or Latin American countries. See Gindling et al. (2016) for a detailed review of the literature on wage differentials.

The database is an updated version of that described in Montenegro and Hirn (2009) Version 4 of the I2D2, which was released in October 2013.

For additional information on the GMD/I2D2 database as well as the full country–year combinations of the mean estimated self-employment earnings premium/penalty by type of self-employment for each country/year observation, these are listed in a companion paper (Gindling et al. 2016)

Another source of data on labor and business regulations we considered was the World Bank Doing Business (DB) project. This data set is one of the earliest to measure business regulations in a comparable way across multiple countries including a large number of developing and transitioning economies. A key component of interest in the DB business data was the “employing workers” which had a significant influence on labor research and subsequently on policy reform recommendations especially in developing and transitioning economies. However, this widely used set of indicators has in recent year been subject to severe criticism. The Employing Workers Indicator has suffered particular criticism on methodological and conceptual grounds.

The index captures the de jure notion of the labor law, which often differs from the de facto laws and regulations on the ground. The index is also widely believed to carry one-sided view of labor market regulations, that of employers, and ignores social objectives set forth to protect workers’ rights to improve work environment standards. This in turn, is argued, which could encourage governments to engage in major deregulatory reforms disregarding much of the legislation set forth in the International Labor Conventions of the International Labor Organization (ILO)

Within each country, we limit our sample to the working age population, 15–65 years old.

The frequency of wage payments is included as a control in order to guard against errors in the coding of wage payment frequencies across surveys, which could otherwise severely distort the results.

There are relatively few countries from other regions of the world in our sample. For example, East Asia and the Pacific are represented only by two observations: one survey from China and one from Timor-Leste The MENA region is represented only by Djibouti and the Republic of Yemen, and South Asia is also represented by only two countries: Pakistan and Bangladesh. North America is represented by three surveys from the USA. The number of countries from Africa in our sample is also small, with only fifteen observations covering 13 countries.

One exception is MENA (Djibouti and Yemen) where non-professional self-employed women earn a 10% self-employment earnings premium. Conversely, professional women earning in the same region earn a whopping 80% penalty compared to their salaried counterpart.

We summarize the results of non-agricultural self-employed worker but do not list the regression results as they are identical to urban self-employed workers.

We also present the results for non-professional own-account self-employed and employers and professionals own-account by gender in the Table A5 in the online appendix

Although the estimates are consistent in sign across specifications (except for non-professionals in the FE/EFW specification), they are only significant (in the right direction) in 9 out of 36 specifications.

It should be noted that in a 2011 IMF study, countries with more liberal credit market regulation (i.e., countries who received higher ratings and therefore favor liberalization in credit markets) suffered more in output growth during the late-2000s financial crisis and global recession. Also, a reduction in regulation does not translate to availability of credit to individuals, especially self-employed and small businesses.

Besley, T., & Burgess, R. (2004). Can labor regulation hinder economic performance? Evidence from India. The Quarterly Journal of Economics, 119(1), 91–134. https://doi.org/10.1162/003355304772839533.CrossRef

De Soto, H. (1989). The other path: the economic answer to terrorism. New York: HarperCollins.

Djankov, S., & Ramalho, R. (2009). Employment laws in developing countries. Journal of Comparative Economics, 37(1), 3–13 https://doi.org/10.1016/j.jce.2008.10.003.CrossRef

Eslava, M., Haltiwanger, J., Kugler, A., & Kugler, M. (2010). Factor adjustments after deregulation: panel evidence from Colombian plants. The Review of Economics and Statistics 92(2): 378–391.

Freeman, R. (2009). Labor regulations, unions, and social protection in developing countries: market distortion or efficient institutions. Handbook of Development Economics, 5(2010), 4657–4702. https://doi.org/10.1016/B978-0-444-52944-2.00008-2.CrossRef

Gallagher, M., Giles, J., Park, A., & Wang, M. (2014). China’s 2008 Labor Contract Law: implementation and implications for China’s workers. Human Relations, 68(2), 197–235. https://doi.org/10.1177/0018726713509418.CrossRef

Gindling, T. H., & Newhouse, D. (2014). Self-employment in the developing world. World Development, 56(April), 313–331. https://doi.org/10.1016/j.worlddev.2013.03.003.CrossRef

Gindling, T. H., Mossaad, N., & Newhouse, D. (2016). How large are earnings penalties for self-employment and informal wage workers? IZA Journal of Labor & Development, 5, 20. https://doi.org/10.1186/s40175-016-0066-6.CrossRef

Gwartney, J., Lawson, R., & Hall, J. C. (2015). "Economic freedom dataset. "Economic freedom of the world: 2015 annual report. Vancouver, British Columbia, Canada: Fraser Institute. Available at https://www.fraserinstitute.org/economic-freedom/dataset. Accessed 2 Nov 2015

Heckman, J. J., & Pagés, C. (2004). Carmen pages, eds.(2004) Law and employment: lessons from Latin America and the Caribbean. New York: University of Chicago Press. https://ssrn.com/abstract=476086

Lehmann, H., & Muravyev, A. (2012). Labor market institutions and informality in transition and Latin American countries. IZA Discussion Paper No. 7035. https://doi.org/10.6092/unibo/amsacta/3910.

Maloney, W. F. (2004). Informality revisited. World Development, 32(7), 1159–1178. https://doi.org/10.1016/j.worlddev.2004.01.008.CrossRef

Micco, A., & Pagés, C. (2006). The economic effects of employment protection: evidence from international industry-level data. IZA Discussion Paper No. 2433. https://ssrn.com/abstract=947097

Montenegro, C. E., & Hirn, M. L. (2009). A new disaggregated set of labor market indicators using standardized household surveys from around the world. Background paper for the world development report 2009. http://hdl.handle.net/10986/9033

Román, C., Congregado, E., & Millán, J. M. (2011). Dependent self-employment as a way to evade employment protection legislation. Small Business Economics, 37(3), 363–392. https://doi.org/10.1007/s11187-009-9241-3.CrossRef

Schneider, F., Buehn, A., & Montenegro, C. E. (2010). New estimates for the shadow economies all over the world. International Economic Journal, 24(4), 443–461. https://doi.org/10.1080/10168737.2010.525974.CrossRef

World Bank. (2013). Doing business 2013: smarter regulations for small and medium-size enterprises. Washington, DC: World Bank Group http://hdl.handle.net/10986/11857.

Title: Self-employment earnings premiums/penalties and regulations: evidence from developing economies
Authors: T. H. Gindling
Nadwa Mossaad
David Newhouse
Publication date: 31-08-2019
Publisher: Springer US
Published in: Small Business Economics / Issue 2/2020
Print ISSN: 0921-898X
Electronic ISSN: 1573-0913
DOI: https://doi.org/10.1007/s11187-019-00248-4

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