In the initial stage of structural transformation, developing countries often witness significant population movement from rural agricultural areas to urban settings. Upon arrival, urban workers face a choice between wage employment and self-employment. The self-employment sector, typically characterised by lower productivity and a high degree of informality compared to wage employment, has led policymakers to prioritise reducing self-employment rates in low-income countries. However, empirical evidence from experiments in countries like China, Brazil, and India suggests that efforts to reduce self-employment have largely been ineffective. This project seeks to identify underlying factors that may hinder industrialisation and sustain high rates of self-employment in the informal sector.
Using International Labor Organization (ILO) data on occupations across countries, this study finds that in low-income countries, self-employed individuals tend to concentrate on occupations related to home production, in contrast to those in wage employment. The study incorporates this empirical finding into an occupational choice model where agents, differing in abilities and preferences for self-employment, choose between producing manufacturing goods in the formal wage-employment sector or providing home production substitutes in the informal self-employment sector. This model is calibrated to reflect the Tanzanian economy. Using this calibrated model, the study conducts policy experiments to examine the impact of reducing the formal sector corporate tax rate and increasing informal sector regulation on lowering the self-employment rate.
Policy simulations indicate that the substitutability of goods provided by the wage and self-employment sectors plays a critical role in reducing self-employment rates. When goods from the two sectors are more distinct, efforts to reduce self-employment inadvertently raise the relative price of goods offered by the self-employment sector, creating a barrier for individuals considering a shift to wage employment. To promote industrialisation, policymakers should consider this "relative price effect," which can make self-employment persistent. Promoting a corporate sector capable of producing home goods at higher productivity can enhance competition with self-employed individuals. Additionally, increasing household productivity through technology adoption can reduce demand for goods produced by the self-employed, further facilitating a shift toward wage employment.
