Nobody's Business but My Own: Self Employment and Small Enterprise in Economic Development

In most poor countries, small firms and self employment are the dominant forms of business enterprise. This phenomenon is true not only in agriculture and the service sector: even in manufacturing, large fractions of the workforce are self-employed. In Ghana, as an illustration, more than 75 percent of the manufacturing workforce were self-employed in 1984. For rich countries, in contrast, self-employed people account for very small shares of manufacturing employment and almost negligible fractions of output. Some observers explain the prevalence of self-employment in poor countries as a phenomenon of distorted policies or credit market imperfections. This paper, in contrast, uses a variant of the Lucas (1978) span-of-control model to ask whether changes in establishment size and employment structure can be explained as a consequence of growing productivity. A model, calibrated to Japanese time series data, is shown to mimic key features of cross-country and time series data. An implication is that changes in relative factor prices, driven by changing productivity, account for a large portion of the cross-country differences in establishment size and self-employment rates. Although policy distortions and market imperfections may also be important in explaining the prevalence of self employment in developing countries, productivity changes alone could account for as much as two-thirds of the variation observed in the cross-section data.